A 401k loan lets you borrow from your own retirement savings and pay yourself back with interest through payroll deductions, with no credit check and no taxable withdrawal as long as you repay on schedule. So how does a 401k loan work in practice? Federal law caps the loan at the lesser of $50,000 or half your vested balance, sets a general five-year repayment deadline, and requires the interest rate to be comparable to what a bank would charge.1Internal Revenue Service. Retirement Topics – Loans The catches show up if you miss payments, leave your job, or count the growth your money isn’t earning while it sits outside the market.
First, Check Whether Your Plan Offers Loans
A plan sponsor is not required to include a loan feature.1Internal Revenue Service. Retirement Topics – Loans Even when a plan does allow loans, it can set stricter limits than the federal rules — a lower dollar cap, a cap on the number of loans outstanding at one time, or documentation requirements the IRS doesn’t impose. Your summary plan description or your plan provider’s online portal will tell you what’s available. If loans aren’t offered, hardship withdrawals or outside financing are your alternatives.
How Much You Can Borrow
Under Internal Revenue Code Section 72(p), your maximum loan is the lesser of $50,000 or the greater of $10,000 and half your vested account balance.2Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts A few examples make the formula easier to read:
- Vested balance of $100,000: half is $50,000, which matches the federal cap, so you could borrow up to $50,000.
- Vested balance of $60,000: half is $30,000, well under the cap, so your maximum is $30,000.
- Vested balance of $15,000: half is $7,500, but the $10,000 floor kicks in, so you could borrow up to $10,000.
Only your vested balance counts. Your own salary deferrals are always 100% vested, but employer matching contributions often follow a vesting schedule that grants you increasing ownership over several years of service.3Internal Revenue Service. Retirement Topics – Vesting If you’re newer to your job, your borrowing capacity may be smaller than your total balance suggests.
Interest, Fees, and Where the Money Goes
The IRS requires the interest rate on a 401k loan to be no more favorable than what a bank would charge for a similar loan.4Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Don’t Conform to the Requirements of the Plan Document and IRC Section 72(p) Most plans set the rate at the prime rate plus one percentage point. The interest you pay goes back into your own account rather than to a lender, which is the feature people mean when they say you’re “paying yourself back.”
Many providers also charge an origination fee when the loan is issued, and some add an ongoing maintenance fee. These fees vary and can make small loans disproportionately expensive. Your plan’s loan documentation should spell them out before you finalize the request.
Applying and Getting the Money
Most plans accept loan requests through the provider’s online portal. You’ll pick a loan amount, choose a repayment term, and provide bank details for direct deposit. Some plans ask for a stated purpose. Processing generally takes a few business days.
Spousal consent is sometimes required for loans over $5,000, but only in plans that offer a life annuity or joint-and-survivor annuity option. Many 401k profit-sharing plans are exempt as long as the plan names the surviving spouse as the full death beneficiary and doesn’t offer an annuity payout.1Internal Revenue Service. Retirement Topics – Loans Your plan administrator can confirm whether the rule applies to you.
Repayment: Five Years, After Tax, on Payroll
Repayments must come in substantially equal installments of principal and interest — a structure called level amortization — with payments at least quarterly.5Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period Most employers meet this by pulling the payment from every paycheck through payroll deduction, which keeps you on schedule automatically. The general repayment deadline is five years from the date of the loan.6Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Two details about those deductions matter for your tax picture. First, they come out of after-tax pay. Second, they aren’t treated as new contributions to the plan, so they don’t count toward your annual contribution limit and don’t earn any employer match.
If You Miss a Payment
Plans can offer a cure period — a grace window to catch up before a missed payment turns into a default. The maximum cure period the IRS allows runs to the last day of the calendar quarter after the quarter in which you missed the payment. Miss a February payment, and you’d have until June 30 to make it up. Plans can adopt a shorter cure period or none at all.5Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period If the loan is still delinquent when the cure period ends, the entire outstanding balance plus accrued interest is treated as a taxable distribution.
Buying a Primary Home Gets a Longer Term
If you use a 401k loan to buy your primary residence, the five-year repayment deadline doesn’t apply. The law allows a longer term, with the exact length set by your plan.7Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts The exception only covers a home you’ll actually live in — investment properties and vacation homes don’t qualify. Expect the administrator to ask for documentation like a signed purchase contract before approving the extended term. Every other rule still applies: the same borrowing limits, level amortization, and at least quarterly payments.
Leaving Your Job Turns the Loan Into a Deadline
Separating from your employer while a loan is outstanding is where 401k loans most often go wrong. Many plans require you to repay the remaining balance shortly after you leave, whether you quit, are laid off, or retire. If you can’t, the plan administrator offsets your account by the unpaid amount. The offset clears the loan using your retirement assets, and the IRS treats it as a distribution — meaning the unpaid balance becomes taxable income for that year, reported on Form 1099-R.1Internal Revenue Service. Retirement Topics – Loans
If you’re under age 59½, the distribution is also generally subject to a 10% early withdrawal penalty on top of ordinary income tax.1Internal Revenue Service. Retirement Topics – Loans On a $30,000 unpaid balance, the penalty alone is $3,000 before income tax at your marginal rate takes another cut.
The Rollover Escape Hatch
You can avoid the tax and penalty by rolling the offset amount into an IRA or another eligible retirement plan. For a qualified plan loan offset triggered by plan termination or severance from employment, the deadline is your tax filing due date, including extensions, for the year the offset happens.8Internal Revenue Service. Plan Loan Offsets The catch is that you have to come up with the cash from somewhere else, since the original loan proceeds are already spent. Rolling that amount in preserves the retirement dollars and closes the tax exposure.
The Costs Even If Everything Goes Right
A 401k loan isn’t free even when you repay on schedule. Three costs get missed most often.
The borrowed money isn’t invested. If the market rises while your loan is outstanding, you don’t capture those gains. Borrowing $25,000 for five years during a stretch when your investments would have returned about 7% annually means roughly $10,000 in growth you never earn. The interest you pay yourself partially offsets that, but plan loan rates usually run below long-term stock market returns, so the net effect is typically a smaller retirement balance.
The interest gets taxed twice. Because repayments come from after-tax pay and aren’t treated as new plan contributions, the money returns to your 401k on an after-tax basis.6Internal Revenue Service. Retirement Plans FAQs Regarding Loans When you withdraw those dollars in retirement from a traditional 401k, they’re taxed again as ordinary income. The interest portion is the cleanest illustration: taxed as earned income today, paid back into the account, then taxed again on withdrawal.
Contributions often drop. With a repayment coming out of every paycheck, many borrowers cut their regular 401k contribution rate to keep take-home pay steady. If your employer offers a match, a lower contribution rate can leave part of that match on the table. Before borrowing, run the numbers on whether you can hold your contribution rate steady while carrying the loan payment. If you can’t, the lost match may cost more than the loan’s stated interest ever would.