Personal Finance

Thinking About Borrowing From Your 401(k)? Read This First

Maurie Backman

Published: February 3, 2025 11:11 am

A lot of people are struggling to make ends meet given our recent bout of rampant inflation. And if you’re someone without emergency savings who runs into an unplanned expense, you may have no choice but to borrow money to cover it.

In that situation, you have options. You could charge the expense on a credit card (perhaps one with a 0% introductory interest rate) and hope it gets paid off before a massive amount of interest accrues. You could also apply for a personal loan and pay it off over time in equal monthly installments.

But if you have money in a 401(k) plan, you might consider borrowing against its balance in the form of a 401(k) loan. And that’s not automatically a terrible idea. But it could also be more risky than you think.

The benefits of a 401(k) loan

It’s not a given that you’ll qualify for a loan — or an affordable one — when you apply. If you don’t have great credit, you might struggle to get a loan or snag a competitive interest rate.

The upside of taking out a 401(k) loan is that you’re borrowing from yourself, so poor credit shouldn’t stop you from having that option. Also, with a 401(k) loan, you’re paying interest to yourself, not a bank or lender.

All told, if your plan allows it, a 401(k) loan can be an easy and convenient way to borrow. But that doesn’t mean it’s an option you should dive into.

The drawbacks of a 401(k) loan

There are a few problems with 401(k) loans you should know about. First, there’s always the risk of not being able to pay back that loan on time. And the consequences there could be pretty severe.

A 401(k) loan that isn’t repaid on time is treated like a retirement plan withdrawal. If you’re not yet 59 and 1/2 years old, that means you’ll risk a 10% early withdrawal penalty on the sum you’ve borrowed. Plus, you’ll face taxes on a 401(k) loan that became a distribution.

Another thing you should know is that if you leave your job while you’re in the process of repaying a 401(k) loan, you may have as little as 60 days from that point to get your balance paid off in full. And if you don’t manage to do that, you can expect it to be treated as a distribution. And to be clear, this rule may apply whether you leave your job voluntarily, or whether you’re let go in the course of a round of layoffs.

Another problem is that if you don’t repay your 401(k) loan, you’ll be out that much money for retirement. And you’ll also be out the gains that sum could’ve generated.

Let’s say you take out a $10,000 loan from your 401(k) at age 40 to cover a home repair and don’t pay it back. Aside from penalties and taxes, you’re losing out on gains from that $10,000 for what could be 25 years, give or take. In fact, assuming your 401(k)’s annual return is 8%, which is a touch below the stock market’s average, not investing $10,000 for 25 years results in the loss of roughly $68,500 in your retirement plan all-in.

You should also know that you may be barred from making contributions to your 401(k) while you’re in the process of paying off a 401(k) loan. That could mean losing a big tax break during that time, since 401(k) plan contributions are tax-free.

Alternatives to a 401(k) loan

Clearly, there are pros and cons to borrowing from your 401(k). So before you make your choice, consider your alternatives. In addition to the options discussed above (a credit card and a personal loan), you may be able to tap your home equity and access the money you need that way.

As a homeowner, you can apply for either a home equity loan or a home equity line of credit (HELOC). With the former, you pay off a lump sum loan in regular installments. With a HELOC, you get access to a line of credit you can tap over a period of time. Your payments can fluctuate, though, because like credit cards, the interest rate on your loan isn’t necessarily set in stone during your entire repayment period.

All told, a 401(k) loan may be a good solution if your credit is poor and you’re unlikely to qualify for a loan elsewhere. But if you’re going to borrow from your 401(k), get yourself on a tight budget to make sure you’re able to make those payments when you’re supposed to.

You may also want to consult a financial advisor before deciding that you’ll take out a 401(k) loan. A professional may be able to identify an alternative solution that makes more financial sense for you.