Should I Borrow From My 401k to Buy a Car?

A 401(k) plan serves as a foundational component of many individuals’ retirement strategies, allowing for tax-advantaged savings and investment growth over decades. As life unfolds, significant expenses, such as purchasing a new car, sometimes arise, prompting individuals to consider various financing avenues. A common question that emerges is whether leveraging one’s 401(k) through a loan is a prudent financial decision for such a large acquisition.

How 401(k) Loans Function

A 401(k) loan allows participants to borrow a portion of their vested retirement savings. The Internal Revenue Service (IRS) sets limits on how much can be borrowed, typically the lesser of 50% of the vested account balance or $50,000. For instance, if 50% of the vested balance is less than $10,000, some plans may permit borrowing up to $10,000.

These loans generally require repayment within five years for general-purpose borrowing. Repayments, which include both principal and interest, must be made in substantially equal installments at least quarterly, often facilitated through payroll deductions. A unique aspect of a 401(k) loan is that the interest paid on the loan goes back into the participant’s own retirement account.

401(k) loans can involve fees. Some plans may charge an origination fee, typically ranging from $50 to $100, and potentially ongoing maintenance fees, which could be $25 to $50. A significant advantage is that these loans do not require a credit check and are not reported to credit bureaus unless a default occurs.

Understanding the Financial Implications

A primary concern with borrowing from a 401(k) is the “lost growth,” as the borrowed funds are no longer invested in the market. This can significantly impact the long-term growth of your retirement savings, even though the interest is repaid to your own account.

A risk arises if employment terminates while a loan is outstanding. Many plans require the full outstanding loan balance to be repaid within 60 to 90 days. Failure to repay the loan by this deadline results in the outstanding balance being treated as a taxable distribution. This means the amount becomes subject to ordinary income tax, and if the individual is under age 59½, an additional 10% early withdrawal penalty applies.

401(k) loan repayments can lead to “double taxation.” The money used to repay the loan is sourced from after-tax income. When those funds, including the interest paid, are eventually withdrawn in retirement, they will be taxed again as ordinary income. Prioritizing loan repayment might lead individuals to reduce or suspend their regular 401(k) contributions, potentially missing out on valuable employer matching contributions during the repayment period.

Alternative Financing Options for a Car

Several financing alternatives exist for a car purchase. Traditional car loans are secured loans where the vehicle itself serves as collateral. These loans typically feature fixed interest rates and repayment terms, and the interest rates can vary widely depending on factors like credit score and whether the car is new or used. As of early 2025, average interest rates for new car loans ranged from approximately 6.73% to 9.23%, while used car loan rates were higher, often between 10.9% and 13.91%. Obtaining a traditional car loan will impact your credit score.

Personal loans are unsecured loans, meaning they do not require collateral. Personal loans often carry higher interest rates compared to secured car loans. Average personal loan interest rates can range significantly, from around 12.57% to 26.51% for borrowers with good credit, with some rates extending up to 36% or more depending on creditworthiness. Similar to car loans, personal loans can affect your credit score.

Using personal savings is another financing method. This option eliminates the need for any loan, avoiding interest payments, origination fees, and the complexities of debt repayment. Utilizing personal savings means the car is owned outright from the start.

Navigating the Decision Process

Deciding whether a 401(k) loan is suitable for a car purchase requires a thorough evaluation of your personal financial landscape. Begin by assessing your current income stability, existing emergency savings, and any other outstanding debts. Your retirement timeline also plays a role, as a longer time horizon generally allows more opportunity for your retirement savings to recover from any lost growth.

Consider the true cost of the car purchase in relation to your overall budget and long-term financial objectives. This involves not only the purchase price but also insurance, maintenance, and fuel costs. Contacting your 401(k) plan administrator to understand the specific rules, interest rates, and any associated fees that apply to your particular plan.

Comparing the total cost of a 401(k) loan, including the potential for lost investment growth and any taxes or penalties in a worst-case scenario, against the total cost of alternative financing options. Develop a realistic repayment plan for any chosen financing method and commit to adhering to it.