You can borrow from most pensions, but the rules and costs depend on your plan type and your age

Whether you can borrow from your pension depends on what kind of pension you have. A defined contribution plan (like a 401(k) or 403(b)) usually lets you borrow against your own balance. A defined benefit plan (a traditional pension that pays a set monthly amount) rarely allows borrowing — you cannot borrow against a promise to pay you later. Some IRAs have no loan option at all, though there are narrow exceptions.

If your plan does allow loans, you will pay interest to yourself, not to a bank. That sounds good until you see the catch: if you leave your job or lose your job before you repay the loan, the IRS treats the unpaid balance as an early withdrawal. You will owe income tax on that amount, plus a 10 percent penalty if you are under 59½. That penalty can cost thousands of dollars on a five-figure loan.

The other major cost is opportunity cost. Money you borrow stops growing in the market. If your pension would have earned 7 percent a year and you borrow $20,000 for five years, you lose roughly $8,000 in growth that you can never get back.

Key Takeaways

  • 401(k) and 403(b) plans usually allow loans; traditional pensions and most IRAs do not.
  • If you leave your job before repaying a 401(k) loan, the unpaid balance becomes a taxable withdrawal plus a 10 percent penalty if you are under 59½.
  • You pay interest to yourself, but you lose the investment growth that money would have earned.
  • The IRS limits 401(k) loans to the lesser of $50,000 or half your vested balance, and you usually have five years to repay.
  • A hardship withdrawal from a 401(k) is permanent and taxed when ready; a loan lets you repay it, but only if you stay employed.

How 401(k) and 403(b) loans work

If your employer plan allows loans, you borrow from your own account balance. The IRS sets a ceiling: you can borrow up to $50,000 or half your vested balance, whichever is less. If your balance is $60,000, you can borrow up to $30,000. If it is $80,000, you can borrow up to $50,000.

You repay the loan through payroll deductions, usually over five years, though some plans allow longer terms for a home purchase. The interest rate is set by your plan administrator — often the prime rate plus 1 or 2 percent — and that interest goes back into your account. You are essentially paying yourself back with interest.

The repayment schedule is strict. If you miss a payment, the plan may treat the loan as in default, which triggers the same tax consequences as an early withdrawal. If you leave your job, most plans require you to repay the full balance within 60 to 90 days. If you do not, the unpaid portion becomes a taxable distribution.

What happens if you leave your job before the loan is repaid

This is where the real cost appears. Suppose you borrow $30,000 from your 401(k), repay $10,000, and then leave your job with $20,000 still outstanding. Your plan will demand repayment within 60 to 90 days. If you cannot pay it back in full, the IRS treats that $20,000 as a distribution from your retirement account.

You will owe income tax on the $20,000 at your ordinary tax rate — if you are in the 22 percent bracket, that is $4,400 in federal tax alone. If you are under 59½, you also owe a 10 percent early withdrawal penalty, which is another $2,000. Your state may add income tax on top of that. The total bill can easily exceed $6,000 on a $20,000 loan.

This risk is real. Job loss, layoffs, and voluntary departures happen. If you are considering a loan, ask yourself whether you could repay it in full within 60 days if you were laid off tomorrow. If the answer is no, a loan is a dangerous choice.

Loans versus hardship withdrawals

Some 401(k) plans offer hardship withdrawals for when ready financial need — medical bills, eviction, foreclosure, or funeral expenses. A hardship withdrawal is permanent. You take the money out, pay income tax on it when ready, and it is gone from your retirement account forever. You cannot put it back.

A loan is different: you repay it, and the money stays in your account growing. But a loan requires you to stay employed and make regular payments. A hardship withdrawal does not — you take the money and that is the end of it, though the tax bill is when ready and steep.

If you are facing a genuine hardship and your plan offers both options, a loan is usually better if you can repay it reliably. A hardship withdrawal makes sense only if you cannot repay a loan and the hardship is severe enough that the tax penalty is worth the cost of solving the problem now.

IRA loans and the 60-day rollover rule

Traditional IRAs and Roth IRAs do not allow loans in the normal sense. You cannot borrow $10,000 and repay it over five years. However, there is a narrow exception called the 60-day rollover rule.

You can withdraw money from an IRA without penalty, provided you deposit it back into an IRA (the same one or a different one) within 60 days. This is technically not a loan — it is a withdrawal and a deposit — but it functions like a short-term loan if you can repay it within the window. If you miss the 60-day important date, the withdrawal becomes taxable and subject to the 10 percent early withdrawal penalty if you are under 59½.

This rule is straightforward to misuse. The 60-day clock starts the day you withdraw the money, not the day you decide to put it back. If you withdraw on January 15 and forget until March 20, you have missed the important date and owe taxes and penalties. You can use this rule only once per 12-month period across all your IRAs combined.

The cost of borrowing from your pension in real numbers

Here is a concrete example. You borrow $25,000 from your 401(k) at 6 percent interest over five years. Your monthly payment is about $483. Over five years, you pay roughly $3,980 in interest — money that goes back into your account, so it is not lost.

But suppose your balance would have grown at 7 percent per year if you had not borrowed. That $25,000 would have become about $35,000 in five years. Instead, because you borrowed and repaid it, you have roughly $29,000 (the original $25,000 plus the $3,980 in interest you paid yourself, minus the growth you lost). The real cost of the loan is the $6,000 in foregone growth.

Now suppose you lose your job after three years, with $13,000 still owed. You cannot repay it in 60 days. The IRS treats that $13,000 as a distribution. At a 24 percent tax rate plus a 10 percent penalty, you owe roughly $4,420 in federal tax. Add state tax and the total bill could exceed $5,000. That $25,000 loan ended up costing you $11,000 or more in lost growth and taxes.

Alternatives to borrowing from your pension

Before you borrow from your retirement account, explore other options. A personal loan from a bank or credit union usually charges 6 to 12 percent interest, but if you repay it, there are no tax penalties and no risk of a surprise bill if you change jobs. A home equity line of credit (if you own a home) often charges less than a personal loan and the interest may be tax-deductible.

A 0 percent balance transfer credit card works for short-term needs if you can repay within the promotional period. Asking family or friends for a loan, while uncomfortable, avoids both interest and tax risk. Even a high-interest payday loan, while expensive, does not put your retirement savings at risk the way a pension loan does.

If you are facing a genuine hardship and your 401(k) plan offers hardship withdrawals, that option is sometimes better than a loan because you avoid the risk of a penalty if you lose your job. The tax bill is when ready and steep, but it is certain. A loan creates the risk of a much larger bill if circumstances change.

Frequently Asked Questions

Can I borrow from my pension if I am still working?

Yes, if your plan allows loans. You can borrow while employed and repay through payroll deductions. The risk appears only if you leave your job before the loan is fully repaid. Some plans allow you to continue making payments after you leave, but this varies by plan — ask your plan administrator before you borrow.

What is the interest rate on a pension loan?

Your plan administrator sets the rate, usually the prime rate plus 1 or 2 percent. It varies by plan and changes over time. Call your plan's customer service line or check your plan documents to find out the current rate before you borrow.

Can I borrow from my pension to buy a house?

Yes, if your plan allows it. Some 401(k) plans extend the repayment period beyond five years for a primary home purchase — sometimes up to 15 years. This lowers your monthly payment but increases the total interest you pay and the time your money is out of the market. Compare this to a mortgage before you decide.

What happens to my pension loan if I retire?

Most plans require you to repay the full balance when you retire. Some allow you to continue making payments from your retirement income, but this is rare. If you cannot repay it, the unpaid balance becomes a taxable distribution. If you are under 59½, you also owe the 10 percent early withdrawal penalty.

Can I borrow from a Roth IRA?

Not directly. Roth IRAs do not allow loans. However, you can withdraw your contributions (not earnings) from a Roth IRA at any time without tax or penalty, and you can use the 60-day rollover rule to withdraw and redeposit earnings if you repay within 60 days. Withdrawing earnings before age 59½ triggers the 10 percent penalty if you miss the important date.