A 401(k) loan allows you to borrow money from your own retirement account balance and pay it back — with interest — over time. Unlike a 401(k) withdrawal, a loan is not a taxable event if repaid correctly, and the interest you pay goes back to yourself. But borrowing from your retirement account comes with significant risks and hidden costs that most people underestimate.
How a 401(k) Loan Works
The IRS allows you to borrow up to 50% of your vested 401(k) balance, with a maximum of $50,000. You must repay the loan within 5 years (or longer if used to purchase a primary residence). Repayments — including interest — come out of your paycheck via payroll deduction.
The interest rate is typically set at the prime rate plus 1%, which in 2026 is around 8–9%. That sounds reasonable, but as explained below, the true cost is higher than the stated rate suggests.
The Hidden Cost: Lost Compounding
The money you borrow is removed from the market and stops growing. If your 401(k) averages 7% annual returns, every dollar borrowed loses that 7% return for the duration of the loan. When you pay 8% interest back to yourself, you might think you come out ahead — but that interest replaces growth that would have happened anyway, and it is paid with after-tax dollars. When you withdraw the money in retirement, it is taxed again. So the interest is effectively taxed twice.
Example: A $20,000 loan for 5 years at 7% average market return costs you roughly $5,750 in lost growth — on top of the loan repayments you are already making.
The Biggest Risk: Job Loss
If you leave your job — voluntarily or involuntarily — while you have an outstanding 401(k) loan, the full balance typically becomes due within 60–90 days. If you cannot repay it, the remaining balance is treated as an early withdrawal:
- Subject to ordinary income tax
- Subject to a 10% early withdrawal penalty (if under 59½)
A $30,000 loan that becomes a distribution can cost $9,000–$12,000 in taxes and penalties at a moderate tax rate. This is the most common way 401(k) loans turn into financial disasters.
When a 401(k) Loan Might Be Acceptable
There are limited scenarios where a 401(k) loan is less bad than the alternatives:
- You need funds for a first-home purchase and have no other source of down payment.
- You would otherwise take on high-interest debt (credit cards at 24%+) and are in a very stable job.
- You have a true emergency with no emergency fund and no other option.
Even in these cases, explore all other options first: personal loans, HELOC, or simply saving longer before making the purchase.
Alternatives to a 401(k) Loan
- Emergency fund: The best defense — 3–6 months of expenses in a liquid account so you never need to borrow from retirement savings.
- Personal loan: Rates for good-credit borrowers in 2026 range from 7–12%. You avoid the retirement account disruption.
- Roth IRA contributions (not earnings) withdrawal: You can withdraw Roth IRA contributions (not earnings) at any time without tax or penalty.
- HELOC: If you own a home with equity, a home equity line of credit may offer lower rates.
How to Take a 401(k) Loan If You Decide to Proceed
- Log into your 401(k) plan portal or contact your plan administrator to confirm your loan limit and check if your plan allows loans (not all do).
- Request the minimum amount needed — do not borrow more than necessary.
- Set up automatic payroll deductions for repayment from day one.
- Build an emergency fund in parallel so you are never in this position again.
- Do not leave your job until the loan is repaid — or have a plan to repay the balance in full before any transition.