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

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

Most 401(k) plans allow you to take a loan against your vested balance — the money that legally belongs to you after you meet your employer's vesting schedule. You borrow from your own account, not from the plan administrator or your employer. The loan is secured by your account balance, which means if you cannot repay it, the unpaid amount is treated as a withdrawal subject to income tax and a 10% early withdrawal penalty if you are under 59½.

The loan itself is not taxable when you receive it. You repay it through payroll deductions, usually over five years, though some plans allow longer terms for loans used to buy a primary residence. The interest rate is set by your plan — typically the prime rate plus 1% to 2% — and that interest goes back into your own account, not to a bank or lender.

Key Takeaways

• You can borrow up to 50% of your vested 401(k) balance, or $65,000, whichever is less, though your plan document may set a lower limit.
• Repayment is mandatory through payroll deductions, and if you leave your job, most plans require the full balance due within 60 to 90 days or the loan defaults into a taxable withdrawal.
• The interest you pay goes back into your account, but you lose the growth that money would have earned if it had stayed invested.
• If the loan defaults, you owe income tax on the unpaid balance plus a 10% penalty if you are under 59½, and you cannot undo the damage by repaying later.

Loan limits and what your plan allows

The IRS sets a ceiling: you can borrow up to 50% of your vested account balance or $65,000, whichever is smaller. If your vested balance is $100,000, you can borrow up to $50,000. If it is $50,000, you can borrow up to $25,000. The $65,000 limit is adjusted annually for inflation and changes each year.

Your specific plan may impose stricter rules. Some plans do not allow loans at all. Others cap loans at a percentage lower than 50%, require a minimum loan amount, or restrict how many loans you can have at once. Check your plan's summary plan description — the document your employer must provide — or ask your plan administrator what the actual limits are for your account.

The vested balance is the key number. If you have been at your employer for two years but the vesting schedule does not fully vest until year five, you can only borrow against the portion that is already vested. Unvested money stays locked until you meet the vesting requirement or leave the company.

How repayment works and what happens if you leave your job

Repayment comes directly from your paycheck through automatic deductions. Your plan sets the repayment schedule — usually five years for a general loan, up to 15 years for a loan used to buy or build a primary residence. You pay both principal and interest, and the interest rate is fixed when you take the loan.

If you leave your job, the loan becomes due in full. Most plans give you 60 to 90 days to repay the entire balance. If you do not repay within that window, the unpaid amount is treated as a distribution. You owe income tax on it at your ordinary tax rate, plus a 10% early withdrawal penalty if you are under 59½. There is no way to undo this — you cannot repay the loan later and recover the tax and penalty.

This is the biggest risk of a 401(k) loan. If you are laid off, fired, or leave voluntarily, a sudden job change can force you to repay thousands of dollars immediately or face a large tax bill. Some people roll the loan into an IRA or another 401(k) at a new employer to extend the repayment period, but this only works if the new plan allows it and if you act within the deadline.

The real cost: lost growth and opportunity

When you borrow $50,000 from your 401(k), that $50,000 stops growing. If the market returns 7% annually, you lose $3,500 in growth in year one alone. Over a five-year loan, the opportunity cost can easily exceed $20,000 or more, depending on market performance.

You do pay interest back into your account, which is better than borrowing from a bank where the interest goes to the lender. But that interest is usually 1% to 2% above prime — currently around 8% to 9% total — while your 401(k) investments historically return closer to 7% to 10% annually. You are replacing a higher-return investment with a lower-return loan repayment.

The math is especially harsh if you borrow during a market downturn and the market recovers while you are repaying. You miss the recovery gains on the borrowed amount, which can cost you tens of thousands of dollars by retirement.

Tax treatment and what the IRS requires

The loan itself is not a taxable event. You do not report it as income when you receive the money. However, the interest you pay is not tax-deductible — unlike mortgage interest or student loan interest, 401(k) loan interest gets no tax break.

If the loan defaults — meaning you do not repay it within the deadline after leaving your job — the unpaid balance becomes a taxable distribution. You report it on your tax return for that year and owe income tax at your marginal rate. If you are under 59½, you also owe the 10% early withdrawal penalty on the unpaid amount. A $50,000 default could result in $15,000 to $20,000 in taxes and penalties, depending on your tax bracket.

Your plan administrator reports the loan to the IRS on Form 5498, and if it defaults, they report the distribution on Form 1099-R. The IRS tracks this, so there is no way to hide a defaulted loan.

Alternatives to borrowing from your 401(k)

Before taking a loan, consider whether a personal loan, home equity line of credit, or credit card makes more sense. A personal loan from a bank typically charges 6% to 12% interest, which is higher than a 401(k) loan rate, but you keep your retirement savings intact and growing. If you own a home, a home equity line of credit often charges less than a 401(k) loan and the interest may be tax-deductible.

If you are facing a genuine hardship — medical bills, eviction, foreclosure — some plans allow hardship withdrawals instead of loans. A hardship withdrawal lets you take money out without repaying it, but you owe income tax and the 10% penalty, and you cannot put the money back. This is generally worse than a loan, but it may be your only option if your plan does not allow loans or if you cannot afford the repayment schedule.

If you have a Roth IRA (separate from your 401(k)), you can withdraw your contributions — not earnings — at any time without tax or penalty. This is not a loan; the money is gone from retirement savings. But if you have a Roth and need cash, this may be less damaging than a 401(k) loan that could default if you lose your job.

Steps to take a 401(k) loan

Contact your plan administrator — usually the benefits department at your employer or the third-party company that manages the plan. Ask for the loan application form and a copy of the plan's loan rules. The application will ask how much you want to borrow and what the loan is for (though the purpose does not affect approval for most loans).

Your administrator will calculate your maximum borrowing amount based on your vested balance and the plan's limits. They will show you the interest rate, the repayment term, and the monthly payment amount. Review these numbers carefully before signing. Once approved, the money is usually deposited into your bank account within a few business days to a week.

Repayment begins on the schedule set by your plan, typically the first paycheck after the loan is funded. Make sure you understand the repayment amount and that it fits your budget. If your circumstances change — you lose your job, your income drops — contact your plan administrator immediately to discuss your options.

Frequently Asked Questions

What happens to my 401(k) loan if I get fired or laid off?

The loan becomes due in full, usually within 60 to 90 days. If you cannot repay it, the unpaid balance is treated as a taxable withdrawal. You owe income tax on the amount at your ordinary tax rate, plus a 10% penalty if you are under 59½. Some people roll the loan into a new employer's 401(k) or an IRA to extend the deadline, but this only works if the new plan allows it and you act quickly.

Can I borrow from my 401(k) if I am self-employed or have a Solo 401(k)?

Yes, Solo 401(k) plans typically allow loans. However, if you are the only employee, you cannot borrow more than 50% of your vested balance or $65,000, and you must repay on schedule. If you miss a payment, the loan defaults and becomes a taxable withdrawal. Consult your plan document or a tax professional about your specific rules.

Can I pay back a 401(k) loan early without penalty?

Yes, you can repay early without penalty. There is no prepayment fee. However, early repayment does not recover the growth you lost on the borrowed amount while it was out of the market, so the opportunity cost remains.

If I take a 401(k) loan, can I still make regular contributions?

Yes, you can contribute to your 401(k) while repaying a loan. Your contributions and the employer match (if any) continue as normal. The loan repayment is a separate deduction from your paycheck.

What is the difference between a 401(k) loan and a hardship withdrawal?

A loan must be repaid; a hardship withdrawal does not. However, a hardship withdrawal is taxable and subject to the 10% penalty if you are under 59½, while a loan is not taxed when you receive it. A hardship withdrawal also permanently reduces your retirement savings, whereas a loan lets you put the money back. Most plans require you to prove financial hardship to take a withdrawal, but not for a loan.