Can You Borrow From Your Pension? Limits, Terms, and Costs

You can borrow from your pension or workplace retirement account only if your employer’s plan includes a loan provision. Federal law permits loans from qualified employer plans — including 401(k)s, 403(b)s, governmental 457(b)s, profit-sharing plans, and traditional defined benefit pensions — but no employer is required to offer them. When loans are available, you can generally borrow the lesser of $50,000 or 50 percent of your vested balance, and you have five years to pay it back. Individual Retirement Accounts are a separate story: you cannot borrow from an IRA under any circumstances.

Which Retirement Plans Can Offer Loans

The Internal Revenue Code allows loans from any “qualified employer plan.”¹ That category covers most workplace retirement accounts:

401(k) plans, the most common source of participant loans
403(b) tax-sheltered annuity plans used by nonprofits and public schools
Governmental 457(b) deferred compensation plans for state and local government workers
Profit-sharing and stock bonus plans²
Traditional defined benefit pensions, which can legally include loan provisions, though many do not

The gap between what the law allows and what your plan actually offers is the point that trips people up. Even when your plan type qualifies, your employer may have chosen to leave loans out of the plan document. To find out, look at your Summary Plan Description or ask your plan administrator.³

IRAs Are Off Limits

If your retirement savings sit in a traditional, Roth, SEP, or SIMPLE IRA, borrowing is not an option. Federal law treats any lending between you and your IRA as a prohibited transaction. Take a loan from your IRA or pledge it as collateral, and the account loses its tax-advantaged status as of the first day of that tax year. The entire balance is treated as distributed to you.⁴ You would owe income tax on the full amount plus, if you are under 59½, a 10 percent early distribution penalty.⁵

How Much You Can Borrow

The federal ceiling is the lesser of $50,000 or 50 percent of your vested account balance. If half your vested balance is under $10,000, the plan may allow you to borrow up to $10,000, but this small-balance exception is optional.³

There is a catch on the $50,000 cap if you have recently paid off a plan loan. The limit is reduced by the difference between your highest outstanding loan balance over the previous 12 months and your current balance. Suppose you paid off a $30,000 loan six months ago and now carry no balance. Your highest balance in the past year was $30,000 and your current balance is zero, so the new ceiling is $20,000, not $50,000.¹

Federal law does not prohibit having more than one plan loan outstanding at once, as long as the combined balances stay within the cap.⁶ Your plan may set its own stricter rules, though. Many cap the number of concurrent loans at one or two, or require a waiting period between them.

Repayment Terms

A plan loan has to be repaid with interest, or the IRS treats it as a taxable distribution.¹ A general-purpose loan must be paid off within five years. A loan used to buy your primary residence is exempt from the five-year rule and can carry a longer term set by the plan.³

Payments must be substantially equal, cover both principal and interest, and come in at least quarterly.¹ Most employers handle repayment through automatic payroll deduction, so you do not have to track quarterly deadlines yourself.

Federal rules require a reasonable interest rate on plan loans.⁷ Most plans set it at the prime rate plus one or two percentage points. Because you are paying the interest back into your own account, it can sound like a great deal. The catch: you repay the loan with after-tax dollars, and that same money will be taxed again when you withdraw it in retirement. The interest portion effectively gets taxed twice.

Missing a Payment

A single missed payment does not automatically trigger a tax bill. If your plan document allows it, you get a cure period to catch up. The maximum cure period runs through the last day of the calendar quarter after the quarter in which the payment was due, so a February payment has until June 30 to be made current.⁸

Miss the cure deadline and the entire outstanding balance, including accrued interest, becomes a deemed distribution. You owe income tax on it, and if you are under 59½, the 10 percent early distribution penalty may also apply.³ A deemed distribution does not cancel the loan, either. You still owe the payments on the original schedule, and those later payments raise your tax basis so the same dollars are not taxed twice.⁹

What Happens If You Leave Your Job

Leaving your employer with a loan outstanding is where borrowers most often get burned. Most plans require you to repay the full remaining balance shortly after your employment ends. If you cannot pay, the plan performs a loan offset, reducing your account balance by the unpaid amount. That offset counts as an actual distribution, subject to ordinary income tax and potentially the 10 percent early distribution penalty.¹⁰

You can avoid the tax hit by rolling an amount equal to the offset into an IRA or another eligible retirement plan. Under a provision added by the Tax Cuts and Jobs Act, you have until the due date of your federal income tax return (including extensions) for the year of the offset, far longer than the standard 60-day rollover window.¹¹ The rollover money has to come from your own resources, though, because the offset amount was already removed from your account.

The Real Cost of Borrowing From Your Retirement

Paying yourself interest sounds painless, but a plan loan carries costs that are easy to miss. The biggest is lost investment growth. While the borrowed amount sits outside the market, it is not earning returns. If your plan’s investments would have grown faster than your loan’s interest rate, your retirement balance ends up smaller than if you had never borrowed. Over a career, that opportunity cost can run into tens of thousands of dollars.

Fees compound the problem. Many plans charge an origination fee when you take the loan, and some add an ongoing maintenance fee. Those charges come out of your account or your loan proceeds, and on a smaller loan they can eat up a real slice of the money. Before you borrow, compare the full cost of a plan loan, including lost growth, fees, and the double-taxed interest, against a home equity line of credit, a personal loan, or other outside borrowing.

Loan or Hardship Withdrawal?

If your plan does not allow loans, or you do not qualify, a hardship withdrawal is a separate route to your retirement money. It is usually the worse option, and worth understanding before you choose:

A plan loan gets repaid with interest. A hardship withdrawal cannot be repaid or rolled back into a plan.¹²
A loan is not taxed if you follow the repayment rules. A hardship withdrawal is taxed as ordinary income, and if you are under 59½, the 10 percent early distribution penalty may apply.
Hardship withdrawals require you to show an immediate and heavy financial need, such as medical bills, funeral costs, tuition, or preventing eviction, and the amount is capped at what covers that need. A plan loan generally does not require you to justify the purpose.¹²
A hardship withdrawal permanently removes the money and any future growth on it. A loan at least puts the money back over time.

1
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
2
Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans
3
Internal Revenue Service. Retirement Topics – Loans
4
Office of the Law Revision Counsel. 26 USC 408 – Individual Retirement Accounts
5
Office of the Law Revision Counsel. 26 USC 4975 – Tax on Prohibited Transactions
6
Internal Revenue Service. Issue Snapshot – Borrowing Limits for Participants With Multiple Plan Loans
7
U.S. Department of Labor. FAQs About Retirement Plans and ERISA
8
Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period
9
Internal Revenue Service. Retirement Plans FAQs Regarding Loans
10
Internal Revenue Service. Plan Loan Offsets
11
Federal Register. Rollover Rules for Qualified Plan Loan Offset Amounts
12
Internal Revenue Service. Retirement Topics – Hardship Distributions