The interest rate on a 401(k) loan is typically the prime rate plus one or two percentage points, fixed at the moment the loan is issued. With the prime rate at 6.75% in early 2026, most borrowers see a rate somewhere between 7.75% and 8.75%. Every dollar of interest goes back into your own retirement account instead of to a bank, which sounds like a bargain and partly is, but the tax treatment and the returns your money isn’t earning while it sits in the loan change the picture.
How Your Rate Gets Set
Plan administrators tie the rate to the prime rate, which is the baseline commercial banks charge their most creditworthy business customers. The Wall Street Journal publishes the widely referenced version, and most plans use the figure from the last business day of the month or quarter when your loan is processed.
The standard markup is one or two percentage points on top of prime. Your plan’s governing documents spell out the exact formula, and you generally cannot negotiate a different rate.
Once the loan is issued, your rate locks in for the life of the loan. If prime moves up or down during your repayment period, your rate does not follow. Payments stay predictable from the first paycheck deduction to the last, and federal law requires roughly equal payments made at least quarterly over a term of no more than five years.1Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Who Gets the Interest You Pay
This is where a 401(k) loan differs most from ordinary borrowing. Interest on a credit card or bank loan is revenue for the lender. Interest on a 401(k) loan goes back into your own account.2Internal Revenue Service. Retirement Topics – Loans The repayments follow your existing investment elections, so a balance split between a stock fund and a bond fund gets repaid into those funds in the same proportions.
That framing makes the loan sound close to free. It isn’t, because of how the money is taxed on both ends.
The Tax Catch Behind “Paying Yourself”
Regular 401(k) contributions go in with pre-tax dollars. Loan repayments, including the interest portion, come out of your paycheck after tax. When you eventually withdraw that money in retirement, the whole balance is taxed again as ordinary income.1Internal Revenue Service. Retirement Plans FAQs Regarding Loans The interest you pay yourself is therefore taxed twice: once when you earn the wages to make the payment, and again when you take it out in retirement.
The interest is also generally not deductible. Federal law denies the deduction for interest on plan loans secured by elective deferrals, which covers most 401(k) balances, and for any loan to a key employee.3Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts So the rate on your statement is the rate you actually bear, without the write-off you might get on a home equity loan.
The Federal Rules That Constrain the Rate
The IRS does not set a specific rate for 401(k) loans, but it sets outer limits. Treasury regulations require that any loan from a qualified plan carry an interest rate and repayment terms that are “commercially reasonable,” meaning comparable to what you’d pay a local bank for a similar loan.4eCFR. 26 CFR 1.72(p)-1 – Loans Treated as Distributions A plan offering 0% would fail the test. An unreasonably high rate could look like an attempt to route extra money into the plan beyond normal contribution limits.
If a loan is reclassified as a distribution for failing these rules, the full outstanding balance becomes subject to ordinary income tax, and a borrower under age 59½ also faces a 10% early withdrawal penalty.5Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions The rate, along with the repayment schedule and other terms, has to be documented in a written, legally enforceable loan agreement.1Internal Revenue Service. Retirement Plans FAQs Regarding Loans
The 6% Cap for Active-Duty Military
Active-duty service members get a separate rule. Interest that accrues on a 401(k) loan during a period of military service is generally capped at 6%, regardless of the rate written into the original loan.6Internal Revenue Service. Retirement Plans FAQs Regarding USERRA and SSCRA The cap is not automatic. You have to send a copy of your military orders to the plan sponsor and request that the limit be applied. Plans may also suspend loan repayments during a military leave of absence for up to a year, with any missed payments made up afterward so the original loan term isn’t extended.1Internal Revenue Service. Retirement Plans FAQs Regarding Loans
What the Rate Doesn’t Show You
The number on your loan statement doesn’t capture the full cost of borrowing from your 401(k). When you pull money out of your retirement investments, those dollars stop earning market returns for as long as the loan is outstanding. Even at 8% interest paid to yourself, your investments might have earned more, or less, than that over the same period. Across a five-year term, the gap between the interest you pay in and the returns you gave up can meaningfully move your retirement balance.
There’s a quieter cost too. If loan payments tighten your budget, you may reduce your ongoing 401(k) contributions during the repayment years. Fewer contributed dollars means less compounding growth, and the shortfall keeps growing for every year between the loan and retirement.
Before treating the loan as cheap money, weigh the whole cost against the alternatives. A home equity loan may offer deductible interest. A personal loan carries a higher rate but simpler tax consequences and no risk to your retirement account if you lose your job. The 401(k) loan rate looks attractive on paper; whether it actually is depends on the numbers you don’t see on the statement.