How to get a 401(k) loan and repayment

A 401(k) loan allows you to access the money in your employer-sponsored retirement account without paying taxes or penalties, and their popularity is growing. According to Empower's Retirement Plan Participant Study, the number of workers taking out 401(k) loans increased 14% over 2023. And 27% thought it likely they'd take out a loan or hardship withdrawal over the next six months. 

If you're considering a 401(k) loan, learn how they work first and compare them to alternatives. Along with benefits like easy access (in many cases), there can be some drawbacks, including tax consequences if you leave your current job and a reduced paycheck. 

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Can I borrow money from my 401(k)?

Generally, yes. If your plan sponsor allows loans, you can borrow against your 401(k) account balance. One of the major benefits of borrowing from your retirement account is that it won’t impact your credit score. You’ll also be paying interest to yourself instead of a lender. However, you’ll need to follow your plan rules and repay the loan in full to avoid penalties.

How much can I borrow from my 401(k)?

You can borrow a maximum of $50,000 or 50% of your vested balance, whichever is less. For example, if you have $200,000 in your 401(k) account, you can borrow up to $50,000 within a 12-month period. If you have $60,000 in your account, you’ll only be able to borrow up to $30,000. However, if 50% of your vested balance is less than $10,000, you may be able to borrow up to $10,000.

Bear in mind, these limits are set by the IRS. Your plan may come with its own limits as well.

How do I borrow from my 401(k)?

1. Contact your plan administrator or human resources team: When you request a loan from your 401(k), you’ll receive important details, like borrowing limits, terms, and interest rates. You’ll also receive an application and/or instructions for applying online.
2. Fill out the paperwork: The application process for getting a 401(k) loan is typically brief.
3. Receive the funds: Your plan administrator should provide you with info on how the funds will be disbursed.
4. Make payments: In most cases, you’ll repay the loan via automatic payroll deductions.
5. Continue regular deposits: In addition to making loan payments, you should continue to make regular deposits into your retirement account to avoid a setback in your future balance.

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401(k) loan repayment rules

You must repay your 401(k) loan in full within five years, or within the term provided in your 401(k) loan agreement, and you must make payments at least quarterly. There’s an exception to the five-year term for loans used to purchase a primary residence.

If you don’t repay your 401(k) loan, it will be treated as a taxable distribution. Unless you’re at least 59 ½ or eligible for an exception, you’ll incur a 10% penalty on the distribution in addition to paying income tax on it.

Your plan administrator is allowed to require full repayment in the event you leave your job or your employment agreement is terminated. Make sure to check your plan rules before making the decision to borrow, especially if you’re considering a job change.

Pros and cons of 401(k) loans

401(k) loans vs. personal loans

24-month personal loans had an average interest rate of 12.49% in February 2024, according to the Federal Reserve. That may be higher than the interest rate offered on loans from your 401(k) plan, and you’ll typically need excellent credit to qualify for the lowest rates. Plus the interest you pay on a 401(k) loan goes into your own account. 

However, personal loans can be available in amounts over $50,000 and may have repayment terms up to seven or 10 years. You won’t need to worry about full repayment if you leave your job, and the funds in your retirement account can continue to grow.

Check out: Best personal loans

401(k) loan vs. withdrawal

If you qualify to take a 401(k) withdrawal, you don't have to pay the amount back. However, you will owe income tax on the amount withdrawn, and you may also be required to pay a 10% early withdrawal penalty if you're under 59 ½. Plus, since you can't return the money to your 401(k), you could also lose out on years of tax-deferred investment growth.

401(k) withdrawal pros:

• No maximum: Unlike a 401(k) loan, withdrawals aren't necessarily limited to up to $50,000 or 50% of your account value. However, certain exceptions to the 10% penalty have maximum withdrawal amounts, and you can only make a 401(k) hardship withdrawal up to the amount you need.
• Active employment not required: You may be able to withdraw money from a 401(k) with a past employer or roll it over into an IRA. 
• Exceptions to the 10% early distribution tax: If you're under 59 ½, you can withdraw up to $1,000 for an emergency personal expense for immediate or unforeseeable financial needs without penalty. You also may be able to withdraw without penalty for other reasons, such as qualified birth or adoption expenses. Note that you'll still owe income tax.
• Not required to pay back: With a 401(k) loan, payments will be deducted from your paycheck, reducing your disposable income. Your paycheck is not impacted by a withdrawal.

401(k) withdrawal cons:

• Lost investment growth: Once you remove the money from your account, it's no longer invested and earning a return. 
• 10% early distribution penalty: If you're under 59 ½, you'll generally have to pay a 10% penalty on top of regular income tax if you don't qualify for an exception.
• Income tax: Withdrawals from a non-Roth 401(k) are subject to regular income tax regardless of when they're taken. Plus, tax may be withheld from the distribution amount.
• Potential bump into a higher tax bracket: Check if a 401(k) withdrawal is enough to raise your tax bracket — you could owe more tax than you expect to. 
• May not be approved: The IRS has laid out early withdrawal exceptions and permits 401(k) plans to allow hardship distributions. If the reason for your withdrawal doesn't qualify for an exception or if you can't qualify for a hardship distribution, a loan may be your only option.

It's usually preferable, and may be easier, to take a 401(k) loan as opposed to a 401(k) withdrawal. You can avoid income taxes on the amount withdrawn and an early withdrawal penalty if you're under 59 ½. Plus, in most cases, you're not required to provide a reason that's subject to approval for a 401(k) loan. 

401(k) loans and taxes

Paying back your 401(k) loan allows you to avoid taxation on the loan altogether. But if you can’t repay the loan, it will be treated as a distribution. You’ll pay income tax plus a 10% penalty for early withdrawal. There are some exceptions, however. If you’re 59 ½ or older, you’ll only pay income tax on the distributed amount (and not an early withdrawal penalty). Other exceptions include: total and permanent disability, qualified adoptions or birth expenses, disaster recovery distributions, terminal illness, and health insurance premiums paid while unemployed.

To qualify for a hardship distribution, you’ll need to demonstrate an “immediate and heavy financial need,” such as a costly medical bill or pending eviction. If you need the money for a down payment on your primary residence, that could also qualify. The amount you can withdraw is limited to what’s required to satisfy the need. Check with your plan administrator to understand whether hardship distributions are allowed and if they're subject to an early withdrawal penalty.

401(k) loan FAQ

Will my employer know if I take a 401(k) loan?

Yes. If you borrow against your 401(k), your employer will have knowledge of the loan. You’ll need to submit an application to your plan administrator, and your payments may be made through payroll deductions. However, the loan will not be reported to the credit bureaus.

Who gets the interest on a 401(k) loan?

The interest on a 401(k) loan goes directly back into your 401(k) account. Essentially, you’re paying interest to yourself when you make payments on a 401(k) loan.

How does a 401(k) loan work if you change jobs?

Depending on the plan, you may be required to repay the balance all at once upon terminating your employment agreement or within 90 days. If you don’t have the cash on hand, the loan may be treated as a distribution. If that happens, you’ll incur a tax penalty and an early withdrawal penalty if you’re under 59 ½ or don’t otherwise qualify for an exception. Both can have a significant negative impact on your retirement savings.

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