401(k) Loans: Should You Borrow Against Your Retirement?

With a 401(k) loan, you can pull money out of your 401(k) to pay for bills, living expenses, or whatever you need. And you can possibly avoid early withdrawal penalties and taxes if you're under 59 ½. You can take out as much as 50% of your vested account balance, up to a maximum of $50,000. Or, if 50% of your vested balance is less than $10,000, you may be able to borrow as much as $10,000. But in most cases, you'll have to repay your loan within five years (or less if you change jobs).

401(k) loans are commonly used to:

• Avoid foreclosure/eviction
• Clear IRS debt
• Buy a home
• Pay medical bills
• Cover emergencies

A 401(k) loan is often a better idea than an early withdrawal, but consider 401(k) loan alternatives and make sure you understand the rules first.

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Is it a good idea to borrow from your 401(k)?

It’s generally not a good idea to borrow from your 401(k) unless you’re purchasing an asset (like a house) that increases in value over time and has tax benefits, or you’re facing an emergency with very bad credit and have no other options. But according to a study by Fidelity Investments, 401(k) loans and withdrawals were on the rise in Q3 2023 — with more people using funds to pay for medical costs and to avoid foreclosure or eviction. 

But borrowing from your 401(k) to cover daily expenses can create a repeated borrowing need, since it reduces your take-home pay. Take the opportunity to instead reevaluate your current budget and your tax deductions. If you’re used to getting a large refund at tax time, consider increasing your deductions so that money is spread out across your paychecks instead.

If you need to borrow for an emergency, consider other options, like an emergency loan. The interest rate will likely be higher, but you could have seven years or more to repay the loan, and you won’t need to jeopardize your retirement to make ends meet.

How does a 401(k) loan work?

With a 401(k) loan, you borrow money from your own account, so there’s no credit check. You repay the balance plus interest over a maximum of five years. Your employer and the IRS have strict borrowing rules, which you need to follow to avoid a 10% early withdrawal penalty and income taxes on the amount withdrawn.

401(k) loan rules

1. Loan amounts: You can borrow 50% or up to $50,000 of your vested account balance. However, some plans will let you borrow up to $10,000 if 50% of your vested account balance is less than $10,000.
2. Repayment: In most cases, you must repay the loan in substantially equal payments on at least a quarterly basis within five years. If you’re unable to repay, the loan will be considered a distribution — making you liable for a 10% early withdrawal penalty and taxes on the balance.
3. Spousal approval: 401(k) plans generally don’t require your spouse to consent to a loan or distribution, but check with your plan to be sure.
4. Repayment terms: The maximum loan term is 5 years, unless the 401(k) loan is used to buy a primary residence. In this case, the repayment term may extend beyond 5 years.
5. Remain with the same employer: To keep a 401(k) loan, you must keep your job during the repayment term. If you’re fired, laid off, or decide to quit, your remaining loan balance could be due immediately, depending on the employer. To avoid this, you may be able to roll a loan with an outstanding balance into an eligible retirement plan by the tax filing deadline. But in most cases, you'll need to pay the balance to avoid tax consequences and penalties for early withdrawal.
6. Interest: In addition to repaying the principal balance, you must also pay interest on the amount borrowed. The amount is set by the plan administrator, but is based on prime. For example, a plan may charge 1% plus the prime rate. However, interest payments go into your own account.
7. Loan fees: You may have to pay an origination fee to get the loan. Some loans also charge an annual fee for each year you haven’t repaid the loan in full. For example, Merrill Lynch charges a $75 establishment fee and a $75 annual fee.

401(k) loan double taxation

Some consider that taking a 401(k) loan results in double taxation of retirement funds. But like any loan you’d take from a bank, you’ll pay a 401(k) loan back with after-tax funds. You’ll also pay taxes when you withdraw those funds in retirement. Simply put, in order to spend money that’s been tax-deferred, you need to pay tax on it. An advantage with a 401(k) loan is that the interest you pay goes to yourself.

What if you can’t pay back a 401(k) loan?

Defaulting on a 401(k) loan is expensive. The remaining unpaid balance of the loan would get added to your gross annual income, so you’d pay taxes on it for that year — plus you’d pay an extra 10% penalty for early withdrawal if you were under 59 ½ when you took out the loan.

However, it’s unlikely you’d default if you remain with your employer. Remember, loan payments are deducted from your paycheck. But if you lose or change your job and don’t roll the loan into an eligible retirement plan, you’d have to pay it back in full. If you can’t, you’d default. If you do roll the balance into an IRA, for example, you’d need to make payments directly and could default if you stop making payments.

Bottom line: Don’t default on a 401(k) loan.

How to get a 401(k) loan

Here is how to take out a loan from your 401(k).

1. Contact your employer: Most employer retirement plans have an online system housing your account info and self-servicing options. That’s where you’d go to take out a 401(k) loan. You could also call your employee benefits center to have someone talk you through the process.
2. Review your balance: Run the numbers for a 401(k) loan using a retirement plan loan calculator to weigh the cost of borrowing. Don’t skip this step. You’ll want to know how this could impact your future.
3. Determine how much you want to borrow: During the loan application, choose the loan amount you need. Remember, you can’t borrow more than 50% of your vested account balance or $50,000. However, if 50% of your vested balance is less than $10,000, you may be able to borrow up to $10,000.
4. Understand your repayment terms, fees, and interest rate: Note any upfront fees charged, what the interest rate is, and how much will be deducted from your paycheck to pay back the loan. Also thoroughly review plan disclosures.

Try to answer these questions for yourself before finalizing the loan documents.

• Do the loan payments fit my budget?
• Do I have the reserves to pay this if I get laid off unexpectedly?
• Will I have time and resources to replenish my retirement savings?
• Is this really my only option? What alternatives am I not considering?

401(k) loans: Pros and cons

The disadvantages of taking a 401(k) loan could outweigh the pros. Be sure to read through to the alternatives below before making a final decision.

Pros

• Lower interest rate: The interest rate on a 401(k) loan is lower compared to other retail lending options. Typically, it’s the prime rate plus 1% to 2%. As of November 2023, the prime rate is 8.50%, which makes a 401(k) loan about 9.50% to 10.50% APR, depending on your plan’s administrator.
• Relatively fast funding: As early as your next paycheck, you could see the money in your account.
• No credit check: A 401(k) loan could be your only loan option if you have bad credit, since there’s no credit check to qualify.
• Automatic repayments: Repaying the loan is simple, as it comes directly from your paycheck before it reaches your account to spend.

Cons

• Limited loan amount: Since the IRS limits 401(k) loan amounts to 50% of your vested balance, you might not be able to borrow as much as you need.
• Potential penalties and taxes: If you lose your job and can’t pay back the loan, it’s considered a distribution and will be taxable as regular income. Plus, if you were under 59 ½ when you took out the loan, you’d owe an additional 10% on the amount of the distribution.
• Reduces potential gains: When you take a 401(k) loan, you’re pulling that money out of the stock market, where it potentially earns you more money. According to Merrill Lynch, a $10,000 loan on a balance of $50,000 that appreciates 5% annually could cost you almost $13,000 in missed gains over 5 years.
• Loan fees: You may have to pay fees for your 401(k) loan. Some employers tack on origination fees, annual fees, or default fees if you fail to repay the loan.
• No protection in bankruptcy. If you have to file bankruptcy to have your debts discharged, your 401(k) loan won’t be one of them. You’re still responsible for repaying the loan. On the bright side, the balance in your 401(k) is usually protected in bankruptcy.

401(k) loans vs. personal loans

Choosing to go with a personal loan may be better than a 401(k) loan, since it doesn’t impact your retirement savings. Although the interest is higher on average, personal loans provide greater flexibility regarding loan amounts, loan terms, and transferability between jobs. The downside is that you’ll need a good-enough credit score and sufficient income to qualify for a personal loan.

Learn More: 401(k) Loan vs. Personal Loan

401(k) hardship distribution

Depending on your situation, you might qualify to claim a hardship distribution from your 401(k) — which means no loan, no repayment, and no 10% penalty for early withdrawal. You’re required to have an “immediate and heavy financial need” and are limited to withdrawing only the amount necessary to satisfy that need. For example, you might qualify if you’re facing:

• Certain medical expenses
• Costs to buy a home
• Tuition and educational expenses
• Eviction or foreclosure on your primary home
• Funeral and burial costs
• Essential repairs for damage to your home (in some cases)
• Losses from a federal disaster declaration

Alternatives to a 401(k) loan

• Personal loan: A personal loan is probably the closest in function to a 401(k) loan. You’ll get the best rates with good credit, but may still qualify for a bad-credit personal loan, especially if you have a cosigner or can secure the loan with collateral.
• State, local, and government programs: Down payment assistance programs (if you’re buying a home) may help with your down payment, provided that you meet program qualifications.
• Equity in your home: A home equity loan or line of credit is a loan that uses your residence as collateral and often carries lower interest rates than other alternatives. You need to have sufficient equity in your home and good enough credit to qualify, and, because the loan is secured by your home, you could lose it if you default.
• Revolving credit: A credit card that has a low or 0% promotional APR could be an excellent alternative to a 401(k) loan. You’ll need good credit to qualify and should pay off all or a bulk of the amount you borrow within the low APR period.

Related: Personal Loan vs. 0% APR Credit Card

Read More:

• What Is a CD Loan?
• HELOC vs. Personal Loan
• Personal Loan Alternatives