How Often Can You Take Out a 401(k) Loan?

Understanding the rules surrounding 401(k) plans and the options they provide, such as taking a loan, is an important part of managing your financial future. A 401(k) plan is a retirement savings vehicle offered by many employers, allowing employees to contribute a portion of their paycheck, often with an employer match, into an investment account. While the primary purpose of these plans is to save for retirement, some allow participants to borrow from their vested account balance. This option can provide access to funds without immediately incurring taxes or penalties, provided specific rules are followed.

Basics of 401(k) Loans

A 401(k) loan is essentially borrowing money from your own retirement savings, rather than from a traditional financial institution. This means the interest you pay on the loan is repaid directly back into your own 401(k) account, effectively paying yourself interest. Eligibility for a 401(k) loan depends on whether your specific employer-sponsored plan offers this feature.

If a plan does permit loans, you typically must be an active employee with a vested account balance. Your vested balance, including your contributions and any vested employer contributions, forms the pool from which you can borrow. Unlike conventional loans, a 401(k) loan does not usually require a credit check, as your own retirement savings serve as collateral.

Limits on Borrowing

The ability to take out a 401(k) loan, and how often, is governed by both federal regulations and the specific rules of your employer’s plan. The Internal Revenue Service (IRS) sets the maximum amount an individual can borrow. This limit is the lesser of 50% of your vested account balance or $50,000. However, there is an exception: if 50% of your vested balance is less than $10,000, you may be able to borrow up to $10,000.

The $50,000 limit is further reduced if you have had an outstanding 401(k) loan within the preceding 12-month period. The maximum new loan amount is $50,000 minus the difference between the highest outstanding loan balance during that 12-month period and the current outstanding balance. This rule can effectively limit how much you can borrow again shortly after repaying a previous loan. For example, if you took a $40,000 loan that you paid down to $32,500, and your maximum is $50,000, your new available loan amount would be $50,000 minus the difference between $40,000 (highest outstanding) and $32,500 (current outstanding), which is $7,500. This leaves $42,500, so you could borrow an additional $10,000 to reach $42,500 in total outstanding loans.

While federal law permits multiple outstanding loans, provided the total remains within the IRS limits, many employer plans impose stricter rules. It is common for plans to allow only one or two outstanding loans at any given time. Therefore, even if you meet the federal criteria for another loan, your plan’s specific provisions may require you to fully repay an existing loan before you are eligible to take out a new one.

Repayment Terms and Schedule

Repaying a 401(k) loan typically involves a structured schedule, with payments usually deducted directly from your paycheck. This automatic repayment method helps ensure consistency and minimizes the risk of missed payments. The law generally requires that a 401(k) loan be repaid within five years. Payments must be made at least quarterly and in substantially level installments that include both principal and interest.

There is an important exception to the five-year repayment rule: if the loan is used to purchase a primary residence, the repayment period may be extended beyond five years, potentially up to 15 years, depending on the plan’s provisions. It is important to understand the implications if your employment ends. If you leave your job, either voluntarily or involuntarily, the outstanding loan balance often becomes due in full within a short timeframe, typically by the due date of your federal tax return for that year, including extensions.

Consequences of Default

Failing to repay a 401(k) loan according to its terms can lead to significant financial repercussions. If the loan is not repaid as scheduled, the outstanding balance is considered a “deemed distribution” from your 401(k) plan. This means the unpaid amount is treated as if it were a taxable distribution from your retirement account.

When a loan becomes a deemed distribution, the entire outstanding balance becomes subject to federal income tax in the year of the default. Furthermore, if you are under age 59½ at the time of the default, the deemed distribution may also be subject to an additional 10% early withdrawal penalty. This can substantially reduce the amount available for your retirement. Even after a loan is deemed distributed, the obligation to repay the loan to the plan remains, although the amount is no longer eligible for rollover.