Can You Borrow Against a 401k? How the Process Works

A 401(k) loan allows you to access a portion of your vested retirement savings without a taxable withdrawal, borrowing from your own account instead of a traditional lender. This differs from a direct withdrawal because the funds are expected to be repaid into the account, typically with interest. Understanding the mechanics of these loans, including eligibility, terms, repayment, and their impact on future savings, is important for anyone considering this option.

Understanding 401(k) Loan Eligibility

Not all 401(k) plans offer a loan feature; its availability is at the discretion of the plan sponsor, usually your employer. If a plan permits loans, specific eligibility requirements must be met by the participant. Common criteria include being an active employee and having a vested account balance, meaning the portion of your account that you fully own.

Most plans require that you do not have any outstanding 401(k) loans from the same plan to qualify for a new one. The specific rules governing who can borrow and under what conditions are detailed within the plan document. Consult your plan administrator or the Summary Plan Description to confirm your eligibility and any particular requirements.

Key Loan Provisions

When a 401(k) plan offers a loan feature, there are specific limits on how much can be borrowed, as set by federal regulations. The maximum amount a participant can borrow is the lesser of $50,000 or 50% of their vested account balance. An exception allows borrowing up to $10,000 if 50% of the vested balance is less than $10,000. For instance, if you have a vested balance of $80,000, you could borrow up to $40,000.

The interest rate is set by the plan, often calculated as the prime rate plus one or two percentage points. For example, with a prime rate of 7.50% as of March 2025, the interest rate might range from 8.50% to 9.50%. Interest paid on a 401(k) loan is repaid directly back into your own 401(k) account, meaning you pay interest to yourself.

The standard repayment period is five years, requiring level payments made at least quarterly. This period can be extended beyond five years if the loan is used specifically for the purchase of a primary residence. As long as the loan is repaid according to the terms, it is not treated as a taxable distribution.

Repaying Your 401(k) Loan

Repayment of a 401(k) loan is facilitated through regular, after-tax payroll deductions. This mechanism ensures consistent payments are made directly from your earnings. The plan administrator provides a repayment schedule, outlining fixed amounts and payment frequency, which must occur at least quarterly.

If a participant leaves employment before the loan is fully repaid, the outstanding balance becomes due much sooner than the original schedule, often requiring full repayment within 60 to 90 days. If the loan is not repaid by this accelerated deadline, the outstanding balance is treated as a taxable distribution. This means the amount will be subject to ordinary income taxes, and if the participant is under age 59½, it will also incur an additional 10% early withdrawal penalty.

Implications for Your Retirement Savings

Taking a loan from your 401(k) can impact the long-term growth of your retirement savings. The money borrowed is no longer invested in the market, meaning it misses out on any potential investment gains or compounding returns it would have otherwise earned during the loan period. This lost opportunity for growth can be substantial over time.

While the interest you pay on the loan goes back into your own account, it may not fully offset the investment earnings that were foregone. The growth that the borrowed funds could have achieved through market participation might exceed the interest paid, potentially leading to a smaller overall account balance at retirement. Consequently, borrowing from your 401(k) can reduce your future retirement income due to this lost growth potential.