How to Borrow Money From Your 401(k) Account

Quick answer

• Borrowing from your 401(k) is a loan, not a withdrawal, meaning you repay it with interest.
• You can typically borrow up to 50% of your vested balance, or a maximum of $50,000, whichever is less.
• Loans must generally be repaid within five years, though longer terms may be allowed for home purchases.
• Interest paid on the loan goes back into your retirement account, effectively to yourself.
• Failing to repay the loan on time can result in taxes and penalties on the outstanding balance.
• Understand the risks and ensure you have a solid repayment plan before proceeding.

What to check first (before you borrow)

Time Horizon

Consider when you’ll need the money for retirement. Borrowing from your 401(k) reduces the amount that can grow over time. If you’re close to retirement, the impact of lost growth could be significant.

Risk Tolerance

While a 401(k) loan is generally considered lower risk than a personal loan because it’s secured by your own money, there are still risks. The primary risk is losing your job, which can trigger immediate repayment obligations. Assess if you can handle that potential pressure.

Emergency Fund

Before considering a 401(k) loan, ensure you have a fully funded emergency fund. This fund should cover 3-6 months of essential living expenses. If you don’t have one, prioritize building it. A 401(k) loan should not be a substitute for an emergency fund.

Fees and Tax Impact

Understand all associated fees, such as loan origination fees or maintenance fees. While the interest you pay goes back to your account, it’s money you could have earned through investment growth. If you default on the loan, the outstanding balance becomes taxable income, and if you’re under 59½, you’ll likely owe a 10% early withdrawal penalty.

Account Type

This guide specifically addresses 401(k) plans. Other retirement accounts, like IRAs, generally do not allow loans. Check your specific 401(k) plan documents or contact your plan administrator to confirm if loans are permitted and to understand the exact terms and conditions.

Step-by-step (simple workflow)

1. Confirm Loan Availability:

• What to do: Check your 401(k) plan documents or contact your plan administrator to see if loans are allowed and what the specific rules are.
• What “good” looks like: You have clear documentation or verbal confirmation from your provider that loans are an option and understand the basic parameters.
• Common mistake: Assuming all 401(k) plans allow loans.
• How to avoid it: Always verify directly with your plan provider.

2. Determine Loan Amount:

• What to do: Calculate the maximum you can borrow based on your vested balance, typically up to 50%, but no more than $50,000.
• What “good” looks like: You know the exact maximum you are eligible to borrow.
• Common mistake: Borrowing more than you can comfortably repay.
• How to avoid it: Borrow only what you absolutely need, not the maximum available.

3. Assess Repayment Capacity:

• What to do: Create a realistic budget to ensure you can make the loan payments from your paycheck.
• What “good” looks like: Your budget clearly shows you can afford the monthly payments without jeopardizing other financial obligations.
• Common mistake: Overestimating your ability to repay.
• How to avoid it: Be conservative in your budget projections.

4. Submit Loan Application:

• What to do: Complete the loan application form provided by your plan administrator or the financial institution managing your 401(k).
• What “good” looks like: The application is filled out accurately and submitted with all required documentation.
• Common mistake: Missing information or errors on the application.
• How to avoid it: Review the application carefully before submitting.

5. Loan Approval and Disbursement:

• What to do: Wait for your loan to be approved and the funds to be disbursed. This may be via direct deposit or check.
• What “good” looks like: You receive the loan funds in your bank account within the expected timeframe.
• Common mistake: Not understanding the disbursement method or timeline.
• How to avoid it: Ask your plan administrator about disbursement details upfront.

6. Set Up Automatic Repayments:

• What to do: Ensure loan payments are automatically deducted from your paycheck. This is the most common repayment method.
• What “good” looks like: Automatic deductions are set up correctly and confirmed to be happening.
• Common mistake: Forgetting to set up automatic payments or having them fail.
• How to avoid it: Verify the automatic deduction setup with your employer’s payroll department and your plan administrator.

7. Monitor Loan Payments:

• What to do: Periodically check your pay stubs and 401(k) statements to confirm loan payments are being made correctly.
• What “good” looks like: Your statements show consistent progress in paying down the loan principal.
• Common mistake: Assuming payments are happening without verification.
• How to avoid it: Make a habit of checking your statements at least quarterly.

8. Plan for Job Changes:

• What to do: Understand the implications of leaving your employer, whether voluntarily or involuntarily.
• What “good” looks like: You know that if you leave your job, you’ll likely need to repay the outstanding loan balance quickly.
• Common mistake: Not realizing that leaving your job often accelerates the loan repayment deadline.
• How to avoid it: Discuss this scenario with your plan administrator before taking out a loan.

9. Complete Repayment:

• What to do: Continue making payments until the loan is fully repaid according to the original schedule.
• What “good” looks like: The loan balance reaches zero, and your account is no longer subject to loan repayment.
• Common mistake: Stopping payments prematurely or missing payments.
• How to avoid it: Adhere strictly to the repayment schedule.

Risk and diversification (plain language)

• Your money is still invested: When you borrow from your 401(k), your existing investments continue to grow or decline. However, the amount you borrowed is no longer invested and growing.
• Lost growth potential: The money you borrow can’t participate in market gains during the loan period. This lost opportunity is a primary cost. For example, if your investments returned 7% annually, and you borrowed $10,000 for five years, you miss out on potential growth on that $10,000.
• Double taxation risk: If you leave your job before repaying the loan, you may have to repay the entire balance quickly. If you can’t, the outstanding amount is treated as a taxable withdrawal, potentially subject to income tax and a 10% penalty if you’re under 59½.
• No guarantee of repayment: While the loan is secured by your 401(k), it’s still a debt. You are obligated to repay it.
• Impact on retirement savings: If you default on the loan, the money is taken from your account, reducing your total retirement nest egg. This can significantly delay your retirement plans.
• Interest paid to yourself: The interest you pay on the loan goes back into your 401(k) account. This means you’re essentially paying yourself interest, which is better than paying interest to an external lender. However, it’s still money that could have been compounding if left invested.
• Diversification is key: While this isn’t directly about diversification of your investments within the 401(k), borrowing from it can concentrate your financial risk. Your retirement savings are tied up in a loan that has repayment obligations, and your job is also tied to your ability to repay.

During market drops, it’s crucial to remember that your investment strategy is designed for the long term. If you’ve borrowed from your 401(k), continue making your payments as scheduled. Avoid making impulsive decisions based on short-term market fluctuations, as this can exacerbate financial difficulties.

Common mistakes (and what happens if you ignore them)

Mistake	What it causes	Fix
Not confirming loan availability	Applying for a loan that your plan doesn’t allow, wasting time and effort.	Always check your plan documents or contact your administrator before assuming loans are permitted.
Borrowing more than you need	Higher monthly payments, increased risk of default, and greater loss of investment growth.	Borrow only the absolute minimum amount required for your emergency.
Underestimating repayment ability	Missing payments, defaulting on the loan, leading to taxes and penalties.	Create a detailed budget and confirm you can comfortably afford the payments.
Not setting up automatic payroll deductions	Forgetting to make payments, leading to missed payments, default, and potential penalties.	Ensure automatic deductions are set up and confirmed with your employer’s payroll and your plan administrator.
Forgetting about the loan after disbursement	Missing payments, losing track of the balance, and not realizing the impact on your retirement savings.	Regularly review your pay stubs and 401(k) statements to monitor payment progress and the outstanding balance.
Not considering job loss implications	Being forced to repay the entire loan balance immediately upon leaving your job, potentially leading to taxes and penalties.	Discuss the loan repayment policy with your plan administrator regarding job termination <em>before</em> taking the loan.
Using it as a substitute for an emergency fund	Depleting your retirement savings for short-term needs, leaving you with less for retirement and no safety net for future emergencies.	Prioritize building a separate, accessible emergency fund before considering a 401(k) loan.
Ignoring the lost investment growth	Underestimating the true cost of the loan, which includes not just interest but also the potential gains your borrowed money could have earned.	Factor in the potential investment returns you’re forfeiting over the life of the loan when deciding if borrowing is worthwhile.
Failing to understand fees	Being surprised by origination or maintenance fees, which add to the overall cost of borrowing.	Ask for a clear breakdown of all fees associated with the 401(k) loan before you agree to it.

Decision rules (simple if/then)

• If you have a fully funded emergency fund (3-6 months of expenses) then you have a stronger foundation for considering a 401(k) loan, because it means you have a safety net for unexpected expenses without needing to tap retirement funds.
• If the reason for borrowing is a non-essential purchase (like a vacation or new gadget) then do not borrow from your 401(k), because retirement savings should be prioritized for essential needs and long-term growth.
• If your plan does not allow loans then you cannot borrow from your 401(k), because loan availability is plan-specific.
• If you are within 5-10 years of your planned retirement age then think very carefully before borrowing from your 401(k), because the lost growth potential has a more significant impact when there is less time for your savings to recover and compound.
• If you anticipate potentially leaving your job in the near future then avoid borrowing from your 401(k), because job separation often triggers immediate repayment requirements that can be financially burdensome.
• If you are unsure about your ability to make monthly payments then do not borrow from your 401(k), because defaulting on the loan leads to taxes, penalties, and a depleted retirement account.
• If the loan fees are unusually high then reconsider borrowing, because excessive fees diminish the value of the loan and increase its overall cost.
• If you can secure a low-interest loan from another source (like a credit union or a secured personal loan) then explore that option first, because it may preserve your 401(k) balance and its growth potential.
• If you need funds for a critical need like medical expenses or to prevent foreclosure then a 401(k) loan might be a necessary tool, because it can provide access to funds when other options are unavailable or too expensive.
• If you are not comfortable with the risk of losing your retirement savings due to job loss and loan default then do not borrow from your 401(k), because this is the most significant risk associated with these loans.

FAQ

Can I borrow from my Roth 401(k)?

Yes, you can typically borrow from the Roth portion of your 401(k) just as you can from the traditional pre-tax portion. The loan rules and repayment obligations are generally the same.

What happens if I miss a loan payment?

Missing a payment can be considered a default. Your plan administrator will likely notify you, and you may have a grace period to catch up. However, continued missed payments can lead to the outstanding balance being treated as a taxable distribution.

How long do I have to repay a 401(k) loan?

Most plans require repayment within five years. However, loans taken to purchase a primary residence may have longer repayment terms, often up to 15 years, depending on the plan.

Is the interest I pay on the loan tax-deductible?

Generally, no. Interest paid on a 401(k) loan is not tax-deductible, even though it goes back into your retirement account. This is different from interest paid on home mortgages.

Will borrowing affect my credit score?

Not directly. A 401(k) loan itself does not typically get reported to credit bureaus. However, if you default and the loan is deemed a taxable distribution, that event could be reported negatively, impacting your credit.

What’s the difference between a 401(k) loan and a withdrawal?

A loan is money you borrow and must repay with interest. A withdrawal is taking money out of your account that you don’t have to repay, but it’s subject to taxes and penalties if taken before retirement age.

Can I take out a 401(k) loan if I’m self-employed?

If you have a Solo 401(k) or an individual 401(k) plan, you can typically borrow from it, subject to IRS limits and plan rules.

How much interest will I pay?

The interest rate is set by your plan, often based on prevailing market rates, like the prime rate. It’s usually a reasonable rate, and remember, the interest is paid back to your own account.

What this page does NOT cover (and where to go next)

• Detailed comparisons of different investment options within a 401(k) plan.
• Strategies for managing debt beyond 401(k) loans.
• Specific tax implications for individuals in various income brackets or states.
• Advanced retirement planning strategies, such as rollovers or annuity considerations.
• Legal advice regarding employer-specific loan policies or disputes.

Next steps could include reviewing your specific 401(k) plan documents, consulting with a financial advisor to assess your overall financial situation, or speaking with your employer’s HR or benefits department for plan-specific details.