Yes, you can borrow from your 401(k), but the rules are strict and the consequences of not repaying are severe

Most 401(k) plans allow you to borrow against your balance, but not all do — your plan document determines whether loans are permitted. If your plan allows it, you can typically borrow up to 50% of your vested balance, with a maximum of $50,000. The loan comes from your own money, not from the employer, and you repay it to yourself with interest. The interest rate is usually the prime rate plus 1 to 2 percentage points, set by your plan administrator.

The catch is timing: you must repay the loan within five years for most circumstances, or within the time you remain employed if your plan allows it. If you leave your job before the loan is repaid, the unpaid balance becomes taxable income when ready, and if you are under 59½, you also owe a 10% early withdrawal penalty on top of income tax. This is why a 401(k) loan can be cheaper than a personal loan in the short term but far more expensive if your employment ends.

Key Takeaways

  • Your plan must permit loans, and you can borrow only up to 50% of your vested balance or $50,000, whichever is less.
  • You repay the loan to your own account with interest, and the repayment period is typically five years unless you leave your job.
  • If you leave your job with an outstanding loan balance, that balance becomes taxable income plus a 10% penalty if you are under 59½.
  • Loan payments reduce your take-home pay because they come from your paycheck after taxes, unlike regular 401(k) contributions.
  • Missing loan payments can trigger a default, which treats the unpaid amount as a distribution subject to income tax and early withdrawal penalties.

How the borrowing limit works

The $50,000 cap is a federal limit that applies to all 401(k) plans. Your plan administrator calculates your borrowing limit by taking 50% of your vested account balance and comparing it to $50,000 — you can borrow whichever amount is smaller. If your vested balance is $80,000, you can borrow up to $40,000. If your vested balance is $150,000, you can borrow up to $50,000, not $75,000.

The limit resets each time you take a loan. If you borrowed $30,000 five years ago and repaid it, you can now borrow up to 50% of your current vested balance again. However, if you have multiple outstanding loans, the total of all loans cannot exceed the $50,000 limit. Some plans also set their own lower limits, so check your plan document or call your plan administrator to find out what you can actually borrow.

Interest rates and repayment terms

The interest you pay on a 401(k) loan goes back into your account, so you are paying yourself. The rate is typically the prime rate (which changes with the Federal Reserve) plus 1 to 2 percentage points. Your plan administrator sets the exact rate within IRS guidelines. As of early 2024, the prime rate is around 8.5%, so a 401(k) loan might cost you 9.5% to 10.5% in interest — higher than some personal loans but often lower than credit cards.

The standard repayment period is five years, with payments made through payroll deduction. If you borrow for a home purchase, some plans allow a longer repayment period, but this varies by plan. You must make payments at least quarterly, and missing a payment can trigger a default. Once you default, the IRS treats the unpaid balance as a distribution, which means you owe income tax on it when ready plus a 10% early withdrawal penalty if you are under 59½.

What happens if you leave your job

This is the biggest risk of a 401(k) loan. If you leave your employer — whether you quit, are laid off, or are fired — while you still owe money on the loan, the unpaid balance is treated as a taxable distribution. You owe income tax on the full amount at your ordinary tax rate. If you are under 59½, you also owe a 10% early withdrawal penalty on top of the income tax.

Example: You borrowed $30,000 and left your job after two years with $20,000 still outstanding. If you are in the 24% tax bracket and under 59½, you owe $20,000 × 0.24 = $4,800 in income tax plus $20,000 × 0.10 = $2,000 in penalty, totaling $6,800 in taxes and penalties on money that was already yours. Some plans offer a grace period (usually 60 to 90 days) to repay the loan in full before the distribution is treated as taxable, but this varies.

Comparing a 401(k) loan to other borrowing options

A 401(k) loan is cheaper than a credit card or payday loan but riskier than a personal bank loan if your job is unstable. The interest rate is usually lower than unsecured personal loans, and you are not creating new debt — you are borrowing from yourself. However, the five-year repayment window is shorter than many personal loans, which means higher monthly payments.

The real cost appears if you lose your job. A personal loan or credit card debt stays with you; a 401(k) loan becomes when ready taxable. If job security is uncertain, a personal loan or home equity line of credit (if you own a home) may be safer. If you are stable in your job and need short-term cash, a 401(k) loan can be the cheapest option because you keep the interest you pay.

Tax treatment of 401(k) loans

Loan payments are not tax-deductible because you are repaying your own money with after-tax dollars. The interest portion of your payment does not reduce your taxable income. This is different from a mortgage or student loan, where you can deduct the interest. However, the interest you pay goes back into your 401(k) account, so it grows tax-deferred like the rest of your balance.

When you repay the loan, you are not making a new contribution — the money comes from your paycheck after taxes. This means your take-home pay is reduced by the full loan payment amount, not just the principal. If you borrow $30,000 over five years, your monthly payment is roughly $600 plus interest, and that full amount comes out of your after-tax pay.

Default and what it costs

A loan defaults when you miss a payment and do not catch up within the grace period set by your plan (usually 90 days). Once in default, the IRS treats the unpaid balance as a distribution. You owe income tax on the full unpaid amount at your ordinary tax rate, plus a 10% early withdrawal penalty if you are under 59½. You also lose the ability to borrow from your 401(k) again for a set period, usually one year.

If you realize you cannot repay the loan, contact your plan administrator when ready. Some plans allow you to extend the repayment period or convert the loan to a withdrawal, though converting it to a withdrawal triggers the same tax consequences. Do not ignore a missed payment — the tax bill arrives whether you acknowledge the default or not.

Frequently Asked Questions

Can I borrow from my 401(k) if I am self-employed?

If you have a Solo 401(k) (a 401(k) for self-employed people), you can set up a loan provision in your plan document. However, if you are the only employee, you cannot borrow from your Solo 401(k) — the IRS prohibits loans to the plan owner. If you have employees, you can borrow, but the rules are the same as for employer plans.

What if I get a new job before my loan is repaid?

Your loan becomes due in full, usually within 60 to 90 days. If you cannot repay it, the unpaid balance is treated as a taxable distribution. Some plans allow you to roll your 401(k) into an IRA or your new employer's plan and continue the loan, but this is rare — ask your new plan administrator before you assume you can transfer the loan.

Can I borrow from my 401(k) to buy a house?

Yes, if your plan allows it. Some plans offer longer repayment periods for home purchases — up to 15 or 30 years instead of five years. However, you still owe the full unpaid balance if you leave your job, and you lose the tax-deferred growth on the borrowed amount. A mortgage or home equity loan is usually cheaper because the interest is tax-deductible and you do not risk losing the loan if you change jobs.

Do I have to pay taxes on the interest I pay back?

No. The interest you pay goes back into your 401(k) account and grows tax-deferred like the rest of your balance. You do not owe income tax on the interest until you withdraw it in retirement. However, the interest payments come from your after-tax pay, so you do not get a tax deduction for them.

What happens if I die before I repay the loan?

The unpaid loan balance is treated as a distribution to your beneficiary. Your beneficiary owes income tax on the unpaid amount, though they may be able to spread the tax over several years if they inherit the 401(k). The remaining balance in your account passes to your beneficiary tax-deferred, as usual.