How to Borrow From Your 401(k) and What It Costs

Yes, you can borrow against your 401(k), but the loan comes from your own money and you repay it to yourself with interest

A 401(k) loan lets you borrow from your account balance while you remain employed at the company sponsoring the plan. You are not borrowing from the plan administrator or your employer — you are borrowing from your own vested balance. The loan must be repaid through payroll deductions, typically over five years, and you pay interest to your own account. The interest rate is usually the prime rate plus one percentage point, set by your plan administrator.

Not all 401(k) plans allow loans. Your plan document determines whether loans are permitted at all, and if they are, what the terms are. Before you assume you can borrow, check your plan's summary or call your plan administrator to confirm loans are available.

Key Takeaways

• You can borrow up to 50 percent of your vested balance, or $50,000, whichever is less, though your plan may set a lower limit.
• The loan must be repaid within five years through payroll deductions, and you pay interest that goes back into your own account.
• If you leave your job, most plans require the full loan balance to be repaid within 60 to 90 days or the remaining balance is treated as a taxable withdrawal.
• Money borrowed from your 401(k) stops growing through investment gains while it is out of the account, which reduces your retirement savings.
• You cannot deduct the interest you pay on a 401(k) loan on your tax return, unlike interest on some other loans.

Loan amount limits and how they are calculated

The IRS sets a ceiling: you can borrow the lesser of 50 percent of your vested account balance or $50,000. If your vested balance is $100,000, you can borrow up to $50,000. If your vested balance is $60,000, you can borrow up to $30,000. Your plan may impose a lower limit, so the actual maximum available to you depends on both the IRS rule and your specific plan document.

The vested balance is the portion of your account that belongs to you outright. Employer contributions may vest gradually over time according to a schedule in your plan. If you have not yet vested in a portion of your employer's contributions, that portion does not count toward your borrowing limit. Your plan statement shows your vested and unvested balances separately.

How repayment works and what happens if you leave your job

Loan repayment is deducted from your paycheck, usually through automatic withholding. The repayment term is typically five years, though loans for the purchase of a primary residence may have longer terms under some plans. You pay interest on the loan, and that interest is credited back to your 401(k) account — it does not go to a bank or lender.

If you leave your job while a loan is outstanding, your plan will require you to repay the full remaining balance within a set window, usually 60 to 90 days. If you do not repay it by that deadline, the IRS treats the unpaid balance as a taxable distribution. You owe income tax on the full amount, and if you are under 59½, you also owe a 10 percent early withdrawal penalty on top of the income tax. This can turn a $30,000 loan into a $15,000 tax bill or more, depending on your tax bracket.

The cost of borrowing: interest and lost investment growth

You pay interest on a 401(k) loan, but that interest goes back into your account, not to an external lender. The interest rate is typically the prime rate plus one percentage point. If the prime rate is 8.5 percent, you might pay 9.5 percent interest. That interest is real money you are paying, and it represents a cost to you even though it stays in your account.

The larger hidden cost is the investment growth you lose. While money is borrowed out of your account, it is not invested in stocks, bonds, or funds. If the market rises 8 percent during the time your loan is outstanding, that 8 percent gain does not apply to the borrowed amount. You are paying 9.5 percent interest but forgoing the potential 8 percent gain — a net cost of roughly 1.5 percent per year, plus the opportunity cost of that compounding over decades until retirement.

Tax treatment of 401(k) loans

A 401(k) loan is not a taxable event when you take it out. You do not owe income tax on the borrowed amount in the year you borrow it. However, the interest you pay is not tax-deductible. If you borrowed $30,000 and paid $2,700 in interest over the repayment period, you cannot deduct that $2,700 on your tax return. This differs from mortgage interest or student loan interest, which may be deductible.

If you fail to repay the loan by the deadline after leaving your job, the unpaid balance becomes a taxable distribution. You owe income tax at your ordinary tax rate on the full amount. If you are under 59½, the IRS also assesses a 10 percent early withdrawal penalty. A $25,000 unpaid loan balance could result in $7,500 to $10,000 in combined taxes and penalties, depending on your tax bracket.

Alternatives to 401(k) loans

Before borrowing from your 401(k), consider whether other options exist. A personal loan from a bank or credit union may carry a lower interest rate and does not put your retirement savings at risk if you change jobs. A home equity line of credit (HELOC) or home equity loan typically has a lower rate than a 401(k) loan and offers tax-deductible interest if you itemize deductions. A Roth IRA allows penalty-free withdrawal of contributions (not earnings) at any time, though this also reduces retirement savings.

If you are facing a financial hardship, some 401(k) plans allow hardship withdrawals in addition to loans. A hardship withdrawal is a one-time distribution for specific reasons — medical bills, home purchase, education, or preventing eviction. Hardship withdrawals are taxable and subject to the 10 percent early withdrawal penalty if you are under 59½, making them more expensive than a loan. However, they do not require repayment and do not create the risk of a tax bill if you leave your job.

When a 401(k) loan makes sense

A 401(k) loan is most defensible when you have a short-term cash need, you are confident you will stay in your job long enough to repay the loan, and you have no lower-cost alternative. Examples include a medical emergency where a personal loan is not available, or a bridge loan to cover a gap between jobs if you are certain the new job will start within the repayment window.

A 401(k) loan is generally not advisable if you are considering changing jobs in the near term, if you are already behind on other debt, or if the borrowed amount represents more than 25 percent of your account balance. The risk of being forced to repay the loan immediately upon leaving your job, combined with the lost investment growth, makes borrowing from retirement savings a high-cost option for most situations.

Frequently Asked Questions

What happens to my loan if I get laid off?

Your employer must give you a window to repay the loan, typically 60 to 90 days. If you do not repay the full balance by that deadline, the IRS treats it as a taxable distribution. You owe income tax on the unpaid amount, plus a 10 percent early withdrawal penalty if you are under 59½. Some plans allow you to roll the loan into an IRA to extend the repayment period, but this requires action before the deadline.

Can I take out a second 401(k) loan if I already have one?

Yes, if your plan allows it. However, the total amount you can borrow across all loans is still limited to 50 percent of your vested balance or $50,000, whichever is less. If you already have a $30,000 loan outstanding and your vested balance is $100,000, you can borrow an additional $20,000 to reach the $50,000 maximum.

Do I pay taxes on the interest I pay into my own 401(k) loan?

No. The interest you pay goes back into your account and is not taxed when it is credited. However, you cannot deduct the interest on your tax return. When you eventually withdraw the money in retirement, you will owe tax on the entire balance, including the interest that was repaid.

Can I borrow from my 401(k) if I am self-employed?

If you have a solo 401(k) (a 401(k) for self-employed people), you can set up a loan provision in your plan document. However, you cannot borrow from your own account — the IRS prohibits self-employed individuals from loaning money to themselves. A SEP-IRA or Solo Roth IRA does not allow loans at all.

What if I cannot repay my 401(k) loan before I leave my job?

Contact your plan administrator immediately. Some plans allow you to roll the outstanding loan into an IRA, which extends the repayment period beyond the typical 60 to 90 days. Others may allow you to make a lump-sum payment before your final paycheck. If neither option is available and you cannot repay by the deadline, the unpaid balance becomes taxable income plus a 10 percent penalty.