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

You can borrow from your own 401(k) balance, but the loan comes with real costs and rules that trap many borrowers

A 401(k) loan lets you borrow money from your own account balance and repay it to yourself over time, usually through payroll deductions. The IRS allows this under specific conditions: your plan must permit loans (not all do), you can borrow up to 50% of your vested balance or $69,000, whichever is less, and you must repay within five years—except for a home purchase, which may allow longer terms. The appeal is obvious: you avoid the credit check and interest rates of a bank loan, and the interest you pay goes back into your own account.

But the catch is equally real: if you leave your job or stop making payments, the loan is treated as a taxable distribution, and you owe income tax plus a 10% early withdrawal penalty if you are under 59½. On a $50,000 loan, this could mean $15,000 to $20,000 in taxes and penalties. The money you borrow also stops earning investment returns while it is out of your account, which costs you growth over time.

Key Takeaways

• Your plan administrator must allow loans, and you can borrow only up to 50% of your vested balance or $69,000, whichever is smaller.
• Repayment is usually through payroll deductions over five years, and the interest rate is typically the prime rate plus 1% to 2%.
• If you leave your job, the loan becomes due immediately—usually within 60 to 90 days—or it is treated as a taxable withdrawal with a 10% penalty if you are under 59½.
• While the loan is outstanding, you cannot make new contributions to the borrowed portion of your account, and you miss out on investment growth on that money.
• A 401(k) loan does not appear on your credit report and does not affect your credit score, but it does reduce your retirement savings.

How to request a loan from your plan

Contact your plan administrator—usually the benefits department at your employer or the third-party company managing your plan. They will provide a loan application form and a summary of your plan's specific rules. You will need to state the loan amount, the reason (though many plans do not require this), and your proposed repayment schedule. The administrator will verify your vested balance and confirm that the amount you are requesting does not exceed the legal limit.

Processing typically takes one to two weeks. Once approved, the money is deposited into a checking account you specify or transferred directly to your employer's payroll system for repayment setup. Some plans allow you to take out a second loan while the first is still being repaid, but this depends on the plan document. Ask your administrator whether your plan permits multiple concurrent loans before you submit your application.

Repayment terms and interest rates

You repay through payroll deductions, usually biweekly or monthly, with the payment amount calculated so the loan is paid off within the required timeframe. The interest rate varies by plan and lender but typically falls between the prime rate plus 1% and the prime rate plus 2%. As of early 2024, this means rates in the range of 9% to 10%, though your plan's rate may differ. Unlike a bank loan, there is no origination fee or application fee—the only cost is the interest itself.

The interest you pay goes back into your 401(k) account, not to a bank or lender. This is a real advantage over external debt: you are paying interest to yourself. However, the money you borrowed stops earning investment returns while it is out of the account, and the interest you pay back is calculated on the principal only, not compounded like investment growth would be. If the market returns 7% annually and you borrow $50,000 for five years, that money would have grown to roughly $70,000 if left invested. Instead, you are paying yourself 9% to 10% interest on money that is not working for you.

What happens if you leave your job

This is where 401(k) loans become dangerous. If you resign, are laid off, or are fired, the loan is typically due in full within 60 to 90 days. If you cannot repay it in that window, the IRS treats the unpaid balance as a distribution from your account. You owe income tax on the full amount at your ordinary tax rate, plus a 10% early withdrawal penalty if you are under 59½. On a $50,000 loan, this could mean $15,000 to $20,000 in taxes and penalties.

Some employers allow you to roll the loan into an IRA or another employer plan if you move jobs, which extends the repayment period. Ask your plan administrator about this option before you leave. If you are laid off or fired, ask immediately whether you can repay the loan in a lump sum to avoid the tax hit, or whether the plan allows a rollover. The 60- to 90-day window is firm, so do not delay in contacting your administrator if your employment ends.

Restrictions on contributions while you have an outstanding loan

While your money is borrowed out of the account, you cannot make new contributions to the portion of your account that is borrowed. If your plan allows you to borrow $50,000 and you do, you cannot contribute new money to that $50,000 until the loan is repaid. This reduces your annual savings and the employer match you might receive on those contributions.

For example, if your employer matches 3% of your salary and you earn $100,000 per year, you would normally receive a $3,000 match. But if you have borrowed $50,000 and your plan restricts contributions to the borrowed amount, you lose the match on that portion. Over five years of repayment, this can add up to thousands of dollars in lost employer contributions and investment growth.

Alternatives to a 401(k) loan

Before borrowing from your 401(k), consider whether your plan offers a hardship withdrawal. These are allowed for specific situations—medical expenses, home purchase, education costs, or preventing eviction—and do not require repayment. However, hardship withdrawals are subject to income tax and the 10% early withdrawal penalty if you are under 59½, so they are often more expensive than a loan in the long run.

A personal loan from a bank or credit union may carry a higher interest rate than a 401(k) loan, but it does not jeopardize your retirement savings or create a tax bomb if you change jobs. A home equity line of credit (HELOC) or home equity loan offers lower rates if you own a home. A 0% credit card offer can work for short-term needs if you can pay it off before the promotional period ends. Each option has trade-offs; the key is comparing the total cost and the risk to your retirement.

Tax treatment and reporting

While you are repaying the loan, there are no tax consequences—the payments are made with after-tax money from your paycheck. However, the interest portion of each payment is not tax-deductible, even though it goes back into your retirement account. When you file your taxes, your plan administrator will send you a Form 1098-Q (if required by your plan) showing the interest paid, but this is informational only.

If the loan is forgiven or goes unpaid, the IRS treats it as a distribution. Your plan administrator will report this on a Form 1099-R, and you will owe income tax plus the 10% penalty (if applicable) on the unpaid balance. This is reported on your tax return for the year the loan is deemed distributed. The tax bill arrives when you file, not when the loan defaults, so budget for this if you know you cannot repay.

Frequently Asked Questions

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

Yes, if your Solo 401(k) plan document permits loans. The same rules apply: you can borrow up to 50% of your vested balance or $69,000, whichever is less. However, you cannot borrow from a SEP-IRA or a SIMPLE IRA—those plans do not allow loans under any circumstances.

What if I have multiple 401(k)s from different employers?

Each plan is separate, and you can borrow from each one independently, up to the $69,000 limit per plan. However, the IRS combines all your 401(k) loans when calculating whether you have exceeded the overall $69,000 limit across all plans. If you have two plans and borrow $40,000 from each, you have hit the limit and cannot borrow more.

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

Yes. You can repay a 401(k) loan in full at any time without penalty or prepayment fees. Early repayment stops the interest from accruing and returns the money to your account sooner, where it can resume earning investment returns.

Does a 401(k) loan show up on my credit report?

No. A 401(k) loan does not appear on your credit report and does not affect your credit score. This is one genuine advantage over a personal loan or credit card, though it also means the loan does not help you build credit history.

What happens to my loan if I retire before it is paid off?

If you retire and are 59½ or older, you can leave the loan outstanding and continue repaying it on the original schedule without penalty. If you retire before 59½, the unpaid balance is treated as a distribution, and you owe income tax on it (but not the 10% penalty, since you have separated from service). Check your plan document for the exact rules, as some plans require full repayment upon retirement.