Should You Borrow From Your 401(k)? A Complete Guide

Borrowing from a 401(k) can feel like a fast, low-cost way to handle debt, emergencies, or large expenses, but federal IRS and ERISA rules make these loans risky if you leave your job or fall behind on payments. In 2025, you can generally borrow up to the lesser of 50% of your vested balance or $50,000 under IRS loan rules, but the money you withdraw stops compounding, repayments are made with after-tax dollars, and any unpaid amount after job separation becomes a taxable distribution. Most plans require payroll-deducted repayment at least quarterly, and terms typically run five years unless used for a primary residence. Because employers are not required to offer loans, always confirm terms in your Summary Plan Description.

• 401(k) loans are optional features; verify availability in your plan’s Summary Plan Description or through your administrator.
• IRS limits borrowing to 50% of vested funds or $50,000, with required level amortization and at least quarterly payments.
• Leaving your job triggers fast repayment, unpaid balances become taxable and may face early-withdrawal penalties under IRS early-distribution rules.
• Repayments use after-tax dollars, and missed market growth can outweigh the perceived benefit of “paying yourself back.”
• Compare alternatives such as home-equity credit, personal loans, or Roth IRA contribution withdrawals before using retirement savings.

Borrowing from a 401(k) is a decision many working Americans face when cash is tight or major expenses arise. A 401(k) loan can be accessible and relatively low cost compared to other borrowing options, but it carries meaningful risks that can affect long-term retirement security. Federal rules set by the Internal Revenue Service and the Department of Labor govern how these loans work, how they must be repaid, and what happens if a borrower leaves their job before the balance is paid back. This guide explains the basics of 401(k) loans, the key regulations that apply, and how to evaluate whether borrowing from retirement savings is the right move. All information is current as of 2025 and reflects the latest federal guidelines.

Can You Borrow? The Basics

Many 401(k) plans allow participants to take loans, but this feature is not guaranteed. Under federal rules, employers may offer loans but are not required to. The Internal Revenue Service makes this clear in its guidance, noting that “a qualified plan may, but is not required to, provide for loans.” You can verify this in the IRS Retirement Plans Loans FAQ.

Loan availability depends on your specific plan. Some employers permit multiple outstanding loans, while others allow only one at a time. Certain plans set minimum loan amounts, impose stricter eligibility requirements, or limit borrowing to specific financial needs. To confirm whether your 401(k) offers loans, and under what terms, review your Summary Plan Description or contact your plan administrator.

Federal protections also apply. ERISA, the law governing employer-sponsored retirement plans, establishes the rules for loan structure, including repayment schedules, interest requirements, and maximum loan limits. Any plan that chooses to offer loans must comply with these ERISA loan standards.

How 401(k) Loans Work

A 401(k) loan allows you to borrow a portion of your vested retirement balance and repay it through automatic payroll deductions. These loans are governed by federal rules under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Service (IRS).

Maximum Borrowing Limit

Under federal law, the IRS sets the maximum you can borrow at the lesser of 50% of your vested account balance or $50,000. The IRS outlines these limits in its official Retirement Plan Loan Rules.

Examples:

• If you have $80,000 vested, your maximum loan would be $40,000.

• If you have $200,000 vested, the $50,000 federal cap applies.

Application Process

To request a loan, you must submit an application through your plan administrator or your employer’s retirement plan portal. You’ll typically select the loan amount, repayment term, and sometimes the purpose, depending on plan rules. Most plans review and approve loan requests within one to two weeks.

Funds Disbursement

Once your loan is approved, the plan sends the proceeds directly to you. Depending on your provider, the funds may be:

• Deposited into your bank account,

• Sent to a linked external account, or

• Issued as a paper check.

Interest Rates and Terms

401(k) loans charge interest, and the payments are deposited back into your own retirement account.

• Interest rate: Most plans set the loan rate at the prime rate plus one to two percentage points. Rates may adjust as the prime rate changes. While the interest you pay is returned to your account, borrowing still affects long-term growth and creates tax considerations.
• Repayment term: The standard repayment period is five years. The IRS allows an extended term of up to 15 years when the loan is used to purchase your primary residence.
• Repayment schedule: Most borrowers repay through automatic payroll deductions, ensuring consistent amortization. Payments must occur at least quarterly, though many plans deduct monthly.

Why People Borrow from 401(k)s

People borrow from their 401(k) for several practical reasons, including consolidating high-interest credit card debt, funding a home down payment, covering emergency medical bills, preventing foreclosure or repossession, and paying for major unexpected expenses.

The appeal comes from advantages such as no credit check, relatively low rates compared with many personal loans, and quick approval through the plan administrator. The Internal Revenue Service confirms that 401(k) loans are permitted when offered by a plan and outlines the governing federal rules in its Retirement Plans Loans FAQ. Because repayments, including interest, flow back into the participant’s own account, many people view the process as “borrowing from themselves.”

A 401(k) loan can be reasonable for certain short-term needs, such as paying off high-interest debt or addressing a temporary cash shortfall, but borrowers must understand the trade-offs, including the risk of reduced investment growth and potential tax consequences if repayment rules aren’t followed.

The Risks and Downsides

A 401(k) loan can hurt long-term savings in several ways. When you borrow, the money taken out of your account stops earning market returns, so you miss potential growth and compounding during the repayment period. Repayment also comes with a tax disadvantage: although the loan goes back into your account, you repay it with after-tax dollars, and those dollars are taxed again when withdrawn in retirement.

There is also job-loss risk. If you leave your employer, most plans require the remaining balance to be repaid within 60 to 90 days. Any unpaid amount becomes a taxable distribution and may trigger a 10% early-withdrawal penalty if you are under age 59½, according to IRS rules on early distributions. Borrowing can also reduce your ability to keep contributing. Many participants pause contributions while repaying the loan, causing them to miss employer matches and slow their long-term savings growth.

Finally, interest on a 401(k) loan is not tax-deductible. Because repayments are made with after-tax dollars and offer no deduction, the overall cost can be higher than borrowing through other traditional options.

Credit Score Impact

A 401(k) loan has no effect on your credit score because it isn’t reported to the credit bureaus and doesn’t require a credit check. It also will not appear on your credit report at any stage. While this can be helpful for borrowers who want to avoid credit inquiries, it also means the loan provides no opportunity to build or strengthen credit history.

Government Oversight and Regulations

401(k) loans must comply with federal requirements set by the IRS and the Department of Labor. A loan can be issued only if the plan specifically allows it, and repayments must follow a level amortization schedule to ensure consistent payments. Borrowers must make payments at least quarterly, and loan limits and repayment terms must follow Internal Revenue Code 72(p).

If any of these rules are not met, the IRS treats the loan as a “deemed distribution,” making the outstanding amount taxable. The Department of Labor also oversees fiduciary compliance under ERISA to ensure plan sponsors administer loans fairly and consistently.

Alternatives to Consider

Before borrowing from a 401(k), compare these alternatives:

• Home equity loans or HELOCs: May offer lower rates and tax deductible interest

• Personal loans: Unsecured options with predictable repayment terms

• 0 percent APR credit cards: Useful for short term needs if paid off before interest applies

• Hardship withdrawals: Different from loans and carry tax consequences

• Roth IRA contribution withdrawals: Allow tax and penalty free access to contributions (not earnings)

Each option has different risks, costs, and tax effects.

Best Practices and Expert Advice

Borrowing from a 401(k) is generally most appropriate when you have a clear short-term need, can repay the loan reliably, expect to remain with your employer, and understand the opportunity cost of taking money out of long-term investments. Federal rules apply to all plans, but your employer’s specific policies may differ. Your plan administrator can explain the interest rate, how repayments are handled, whether matching or contributions may be affected, and what happens to the loan if you leave the company.

For example, borrowing $20,000 at a 6 percent interest rate over five years results in a monthly payment of about $386 and total repayment near $23,160. Although the interest goes back into your account, the withdrawn funds no longer benefit from potential market gains. If your portfolio could have earned around 7 percent annually, the lost growth over five years may exceed $8,000, depending on market conditions.

Special Circumstances

Certain situations can affect how 401(k) loans are handled. During the COVID-19 pandemic, the CARES Act temporarily increased loan limits and allowed suspended repayments, but these measures have now expired. If your plan is terminated or your employer switches recordkeepers, the way an outstanding loan is administered may also change. Federal bankruptcy law generally protects 401(k) assets, but loan balances do not receive the same treatment.

Actionable Takeaways

Before taking a 401(k) loan, start by confirming whether your plan actually permits borrowing. Plan rules vary, so reviewing your Summary Plan Description or contacting your administrator is the most reliable way to know what’s allowed.

It’s equally important to understand the repayment schedule and the consequences if you leave your job. Many plans require the remaining balance to be repaid quickly after separation, and unpaid amounts may be treated as taxable income.

When evaluating the cost of borrowing, consider the opportunity cost, not just the interest rate. Money taken from your retirement account misses potential market growth, which can have a long-term impact on your savings.

Take time to compare alternatives such as personal loans or home-equity products, which may offer competitive rates or different repayment flexibility. This helps ensure that a 401(k) loan is truly the best option for your situation.

If your budget allows, continue contributing to your 401(k) while making loan payments so your savings can keep growing. And before finalizing any decision, consult a financial professional who can help you assess the long-term impact on your retirement goals.