A 401(k) loan is money you borrow from your own vested retirement balance and repay to your own account with interest. Before retirement, the costs are lost growth and fees, and the risks are taxes and penalties after default or job loss.
It can look cheaper than bank debt because the interest goes back to you. It still leaves less money invested. That gap matters most when you are close to retirement.
Table of Contents
- How Much Can You Borrow and How Fast Must You Repay?
- What Will It Really Cost?
- What Happens If You Leave Your Job or Miss Payments?
- How Can You Lower the Risk?
How Much Can You Borrow and How Fast Must You Repay?
According to the IRS, a qualifying loan has a federal ceiling, described in IRS loan rules. The limit is the lesser of 50% of your vested balance or $50,000. A worker with $120,000 vested could borrow up to $50,000.
The same IRS rules generally require repayment within five years in substantially level payments at least quarterly. Only a loan to buy a primary residence can run longer. Ask your administrator for your exact limit and payment schedule. Get the payment dates in writing before you borrow.
What Will It Really Cost?
National Debt Relief, citing Fidelity, reports most plans charge prime plus 1-2 points, repaid into your own account. At 6.75% prime, that means about 7.75%-8.75%, plus origination and maintenance fees. According to Investopedia, borrowed money misses market growth while it is out of the account, as explained in Investopedia analysis of 401(k) borrowing.
Interest paid to yourself does not replace that missed compounding. Investopedia also notes some plans block new contributions until the loan is repaid, and repayments use after-tax dollars. That can cost you matching funds and long-term growth.
📨 Get Free Medicare Guides Alerts
Free · No spam · Unsubscribe anytime
What Happens If You Leave Your Job or Miss Payments?
According to FINRA, workers who leave a job may have to repay the full balance quickly, as warned in FINRA guidance on job loss. FINRA warns that borrowers after a layoff generally must repay within 90 days or face income taxes plus the 10% penalty. According to the IRS, any unpaid balance that breaks the loan terms counts as a taxable distribution of ordinary income.
Borrowers under age 59½ also owe a 10% early-withdrawal tax. The IRS allows extra time for a qualified plan-loan offset from severance or plan termination. You may roll over that offset to an IRA or eligible plan by the tax-return due date including extensions.
How Can You Lower the Risk?
Treat a 401(k) loan as a last resort after cheaper, safer cash options. Borrow only what you must and keep the term as short as you can manage.
Before you sign, confirm the payoff deadline after job exit. Line up backup cash to repay the balance or roll it over on time.
- Borrow less than the maximum to keep more money invested.
- Keep making contributions if your plan allows them during the loan.
- Set autopay for at least the quarterly due dates to avoid default.
- Keep backup cash for fast repayment if you quit or lose your job.
You Might Also Like
- What Does a Pooled Employer 401(k) Plan Mean for Retirement Savings?
- Is a 401(k) Really a “Trap” for Retirement Savers?
- How Does a 401(k) Hardship Withdrawal Affect Retirement Benefits?