401(k) Loans

Withdrawals aren’t the only way to pull money from your 401(k). You can also take out a loan.

401(k) personal loans let you borrow from your retirement savings, essentially turning your retirement fund into your private lender. 401(k) loans don’t require a credit check; you can use them for almost anything—even a down payment on a house.

These loans have potential tax and investment implications, so understanding how they work is crucial for financial decision-making. Do 401(k) loans make sense for you? Keep reading to find out.

How do 401(k) personal loans work?

To borrow from your 401(k), you’ll need to work closely with your plan administrator. Here’s how the process works:

1. Ask your administrator if your plan allows 401(k) loans. Not all 401(k)s offer loans. Your HR representative or the company that manages your 401(k) can help you determine if yours does.
2. Apply for a 401(k) loan through your plan administrator. 401(k) loans don’t involve a credit check, but you must meet your administrator’s eligibility requirements. Your employer also has to approve your loan application.
3. Receive your loan funds, if your administrator and employer okay your 401(k) loan. This can take as little as a few days or up to several weeks. You could receive your funds with your regular paycheck, as a separate direct deposit, or as a paper check.

When you apply for the loan, you’ll specify how much you want to borrow and how long you’ll take to repay it. There are a few restrictions to keep in mind, however:

• Borrowing limits: The IRS caps 401(k) loans at the lesser of 50% of your vested balance or $50,000, though your administrator may set lower limits.
• Repayment terms: You must repay your 401(k) loan within five years, but you can pay it back earlier if you’re able. If you use your loan to purchase a home, you may qualify for a longer repayment period.
• Spousal consent: If you’re married, your plan administrator may require you to obtain your spouse’s consent before it funds your loan.

Tip

If you leave your employer before paying back your 401(k) loan, you may be required to repay your loan in full or be subject to taxes and penalties.

You can repay your loan in biweekly, weekly, monthly, or quarterly installments, depending on what intervals your administrator allows. Each payment will include principal and interest, but interest paid on 401(k) loans differs from regular loans. 

With 401(k) loans, interest rates don’t depend on your creditworthiness. 401(k) loan rates are usually one to two points higher than the prime rate, regardless of how high or low your credit score is.

Furthermore, the interest you pay on a 401(k) loan isn’t money lost. Instead, that interest goes right back into your retirement account.

There is no hard and fast age at which a 401(k) loan no longer makes sense. However, it begins to make less sense beyond age 59 1/2 because, in many cases, that’s when withdrawals can be taken from a 401(k) penalty-free.

Andrew Steger

CFP®

Pros and cons of getting a personal loan from 401(k)

Pros

• You can use your 401(k) savings tax- and penalty-free.

  If you repay your 401(k) as agreed within five years or less, you can avoid paying taxes or penalties on those funds like you would with a 401(k) distribution.

• You pay interest to yourself.

  When you take out a 401(k) loan, you are your lender. Rather than the interest paid to a bank or private lender, it replenishes what you borrowed from your 401(k).

• Interest rates may be lower than with a traditional loan.

  Because 401(k) loan rates aren’t based on the borrower, you might get a lower interest rate with a 401(k) personal loan than a traditional one.

• 401(k) loans don’t hurt your credit.

  You won’t get any hard inquiries on your credit report, so your credit score won’t take a hit if you borrow from your 401(k). In fact, your 401(k) loan won’t show up on your credit report at all.

• You don’t have to put up any collateral.

  Unlike loans you secure with your home or vehicle, 401(k) loans don’t require collateral. You won’t risk losing your assets if you can’t make payments.

Cons

• You miss out on potential investment earnings.

  Every day your 401(k) is depleted, your 401(k) doesn’t grow as much as it could. Carefully weigh how a 401(k) loan could impact your retirement planning, particularly if you hope to retire sooner rather than later.

• You miss out on potential tax savings.

  You might fund your 401(k) with pre-tax dollars, but you’ll repay your loan with after-tax income. Then, when you start taking distributions, you’ll pay taxes on those, too. In effect, you’re paying taxes twice on the same earnings.

• Your 401(k) loan might prevent you from making contributions.

  Not only would this preclude you from reducing your tax liability while you pay back your loan, but you’ll also have to wait even longer to get your retirement savings back on track.

• You may have to repay your loan in full if you change jobs.

  If you leave your current employer—voluntary or otherwise—while you have an active 401(k) loan, your employer could accelerate your repayment.

• Late payments could incur additional taxes and penalties.

  If you fall far enough behind on your payments, the IRS treats the remaining balance on your 401(k) loan as a distribution. That means you’ll owe taxes on those funds—and possibly penalties, too.

401(k) loan vs. personal loan

401(k) loans and personal loans share many similarities. Both loan types have few usage restrictions, and you can (usually) repay each loan early without repercussions.

Still, you’ll notice several differences when you look at how personal loans work compared to 401(k) loans. The table below shows some of the most notable:

	401(k) loan	Personal loan
Credit check	❌	✅
Who approves?	Employer	Lender
Interest rates	Prime rate + 1-2%	Based on credit
Loan terms	5 years or less	2 – 12 years
Loan maximum	50% of balance or $50,000	Up to $100,000
Taxes and penalties	🤔	❌
Funding speed	At least a few days	As soon as same day

Credit impact

Unlike 401(k) loans, personal loans always require a credit check—and always result in a hard inquiry on your credit report. Your credit check determines:

• Whether you’re approved
• How much you can borrow
• Your interest rate

Conversely, 401(k) loan terms don’t consider your credit. Instead, they’re set by your plan administrator and based on IRS rules. As a result, there’s not nearly as much unpredictability or variation between borrowers with the same employer.

Similarly, personal loan payments are reported to the credit bureaus, whereas 401(k) loan payments are not. If you need to build up a positive payment history, you can’t do that with a 401(k) loan.

Loan limits and repayment terms

Personal loans come with more flexible repayment periods than 401(k) loans. LightStream, for example, offers terms between 24 and 144 months. However, 401(k) loans require you to repay your loan in five years or less, with very few exceptions.

In addition to the potential for more flexible repayment periods, personal loans also come with larger loan amounts. You can borrow up to $100,000 with SoFi but only up to $50,000 with a 401(k) loan.

Interest, fees, taxes, and penalties

You won’t pay taxes or penalties on a personal loan but will pay interest. How much you pay in interest depends on your rate and repayment period. Interest paid on a personal loan goes directly to the lender, unlike 401(k) loan interest that goes back into your retirement fund.

You might pay 401(k) and personal loan fees. Your administrator may charge processing or annual fees when you take out a 401(k) loan, much like the origination fee you might pay to get a personal loan.

Personal loan fees vary by lender, and many of the best personal loans don’t charge any fees whatsoever. 

When should I choose a personal loan over a 401(k) loan?

Whether a personal or 401(k) loan makes the most sense depends on several factors. A personal loan might be a better option if you:

• Can get a lower interest rate than with a 401(k) loan
• Want your payments reported to the credit bureaus
• Need to borrow more than you get from your 401(k)
• Don’t want a loan that’s linked to your job

However, a 401(k) loan may be wiser when you:

• Can’t qualify for a lower interest rate with a personal loan
• Don’t want your loan to show up on your credit report
• Have a vested 401(k) balance that is sufficient to cover your needs
• Have a strategy for repaying your loan without derailing your retirement

When in doubt, do your research. Talk to your 401(k) administrator, and prequalify with four or five personal loan lenders. 

Compare the rates you’d get with each loan type and your payments and borrowing limits. Weigh those elements against your short-term needs and long-term goals to determine which option is best for your situation.

Ask the expert

Andrew Steger

CFP®

401(k) loans should generally be a last resort. While there are certain occasions when a 401(k) loan should be utilized, such as during a hardship—for example, when you need to pay medical bills, tuition, or funeral expenses—other avenues, such as reviewing the budget, comparing personal loan rates, and exploring other options make sense before pursuing a 401(k) loan. 

Alternatives to 401(k) loans

Personal loans aren’t the only alternative to 401(k) loans. You could also consider:

Alternative	When it makes sense
401(k) withdrawal	You won’t qualify for a traditional loan or 401(k) loan
Home equity loan	You’re funding a large, one-time expense
Home equity line of credit (HELOC)	You need continual access to cash

401(k) withdrawals

Unlike 401(k) loans, you’re not required to repay 401(k) withdrawals. But withdrawals could increase your tax liability or incur a 10% early distribution penalty if you’re younger than 59½.

Depending on your 401(k) administrator, you may be required to provide evidence that you’re using the funds for a qualified hardship (like covering funeral expenses or staving off eviction).

Given the tax and penalty implications, you may deem a 401(k) withdrawal too costly. But if you can’t qualify for other forms of financing and can’t take out a 401(k) loan, it may be your only option.

Home equity loans and HELOCs

Own a home? Have equity? Instead of pulling from your retirement fund, you could use a home equity loan or HELOC.

Both of these financing tools convert your home equity into cash. With home equity loans, you’ll receive a lump-sum payment that’s repaid like a traditional loan. HELOCs work more like credit cards. You borrow against your home equity as needed, up to your credit limit. 

The caveat with these home equity loans and HELOCs is that your home serves as collateral. If you default on your payments, you could lose your house.