Federal law lets you borrow from your 401(k), but only within tight limits: the lesser of $50,000 or the greater of half your vested account balance or $10,000, repaid in substantially level payments made at least quarterly, with the loan paid off inside five years. Those are the core 401(k) loan rules under Internal Revenue Code Section 72(p), and your employer’s plan document layers additional restrictions on top of them. Break any of these rules and the IRS treats the outstanding balance as a taxable distribution, plus a 10 percent penalty if you’re under 59½.
How Much You Can Borrow
The maximum loan under IRC 72(p)(2)(A) is the lesser of two figures:
- $50,000, reduced by the difference between your highest outstanding loan balance during the previous 12 months and your current outstanding balance on the date of the new loan.
- The greater of 50 percent of your vested account balance or $10,000.
The $10,000 floor is the part people miss. If your vested balance is $15,000, half is $7,500, but the floor still lets you borrow up to $10,000.1Internal Revenue Service. Borrowing Limits for Participants With Multiple Plan Loans
The $50,000 side is not a flat ceiling either. Say you had $40,000 outstanding six months ago and currently owe $30,000. The $50,000 gets reduced by that $10,000 difference, so your new maximum is $40,000.2Internal Revenue Service. Retirement Plans FAQs Regarding Loans The 12-month lookback exists to stop participants from cycling loans to access more cash than Congress intended.
Higher Limits for Federally Declared Disasters
The SECURE 2.0 Act lets employers raise the ceiling for participants affected by a federally declared major disaster. For qualifying individuals, the maximum jumps to the lesser of $100,000 or 100 percent of the vested balance (minus outstanding loans), and repayment deadlines can be extended by up to a year.3Internal Revenue Service. Disaster Relief Frequently Asked Questions: Retirement Plans and IRAs Under the SECURE 2.0 Act of 2022 Employers are not required to adopt these expanded rules, so check your plan if you live in a declared disaster area.
How Long You Have to Repay
Most 401(k) loans must be repaid within five years. There’s one exception: a loan used to buy a dwelling that will be your primary residence can carry a longer term, and many plans allow 15 to 30 years for these.4Internal Revenue Service. Retirement Topics – Loans
Whatever the term, the statute requires substantially level amortization with payments made at least quarterly.5Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts Most plans collect through payroll deduction each pay period, which satisfies that easily. One trap to know about: if the loan terms don’t require level amortization from day one, the entire loan is a deemed distribution when it’s issued, not just any shortfall later.6eCFR. 26 CFR 1.72(p)-1 – Loans Treated as Distributions The structure has to be right from the start.
Suspensions During a Leave of Absence
Non-military leave, such as FMLA, short-term disability, or any unpaid leave where payroll deductions stop, allows your plan to suspend repayments for up to a year. The five-year deadline doesn’t move, though. When you return you’ll either raise the remaining payments or make a lump-sum catch-up.7Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Don’t Conform to the Requirements of the Plan Document and IRC Section 72(p)
Military service under USERRA is treated more generously. Repayments can be suspended for the whole period of duty, and the five-year deadline is extended by the length of service. Interest during military service is generally capped at 6 percent if you give the plan sponsor a copy of your orders.8Internal Revenue Service. Retirement Plans FAQs Regarding USERRA and SSCRA
Interest, Fees, and the Double-Tax Wrinkle
ERISA requires a “reasonable rate of interest” but doesn’t set a number.9Office of the Law Revision Counsel. 29 USC 1108 – Exemptions From Prohibited Transactions The typical benchmark is prime plus one percentage point, though your plan document controls the actual formula. Interest goes back into your own account rather than to a bank, which sounds like a wash. It isn’t quite. The interest portion of every payment comes from after-tax dollars, and that same money gets taxed again when you eventually withdraw it in retirement. The principal is largely neutral; the interest is genuinely taxed twice.
On top of interest, most recordkeepers charge an origination fee and a quarterly or annual maintenance fee. On a smaller loan these can meaningfully raise the effective cost. Your plan’s fee schedule will show the amounts before you finalize the request.
What Your Plan Document Controls
Federal law sets the outer boundaries. Your employer’s plan document runs everything inside them. Employers aren’t required to offer loans at all. If yours does, the plan sets the minimum loan amount (commonly $1,000), how many loans you can have out at once, and whether you need a stated reason to borrow. Some plans allow general-purpose loans with no justification. Others restrict borrowing to hardship situations and may want proof that no other resources are reasonably available.
The administrator can’t approve anything that contradicts the written plan, even if the request fits inside the federal caps. A plan that says two active loans maximum means two, no matter how much room you have under the $50,000 ceiling.
What Happens If You Miss a Payment
A missed payment doesn’t automatically trigger a deemed distribution. IRS regulations provide a cure period that runs through the last day of the calendar quarter after the quarter in which the payment was due.10Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period Miss a February 15 payment and you have until June 30 to catch up. Your plan can adopt a shorter window, or none at all, so read the loan terms before assuming you have the full buffer.
If the cure period lapses, the entire outstanding balance plus accrued interest becomes a deemed distribution. Here’s the part that surprises people: the deemed distribution doesn’t wipe out the debt. You still owe the plan. But the IRS treats the balance as taxable income in the year of default, and the 10 percent early distribution penalty applies on top if you’re under 59½.11Internal Revenue Service. Plan Loan Failures and Deemed Distributions You get taxed on money you already spent, and you still have to pay it back.
Leaving Your Job With an Outstanding Loan
This is where most 401(k) loan problems actually happen. When you leave an employer, many plans require you to repay the full outstanding balance. If you can’t, the plan reduces your account balance by the amount owed. That reduction is a plan loan offset, and it’s treated as an actual distribution rather than a deemed one.12Internal Revenue Service. Plan Loan Offsets
The distinction matters because of your rollover options. If the offset is a “qualified plan loan offset,” meaning it happened because you separated from employment or the plan terminated, you can roll the offset amount into an IRA or another eligible retirement plan by your tax filing deadline (including extensions) for the year of the offset.4Internal Revenue Service. Retirement Topics – Loans Before the Tax Cuts and Jobs Act took effect in 2018, you had 60 days. Now you generally have until about April of the following year to come up with the cash and avoid income tax and the 10 percent penalty. Miss that window and the full offset amount lands on your tax return as ordinary income.
A few plans let you keep making payments after separation, but that’s unusual. Ask before you assume it.
Is Borrowing From Your 401(k) Worth It
The double-taxation of interest gets talked about most, but the bigger cost for most borrowers is opportunity cost. Dollars that leave your investment portfolio for the loan period aren’t earning market returns. You repay yourself at prime plus one, but a diversified portfolio over a long horizon typically returns more than that. Over decades, the gap compounds.
The effect is largest for younger workers. A 35-year-old borrowing $20,000 for five years isn’t just paying interest; they’re giving up 30 years of compounding on the returns those dollars would have earned during the loan period. The interest paid back into the account doesn’t recover the market exposure that was lost. For someone in their late 50s, the compounding window is shorter and the gap is smaller, which is why financial planners tend to be less alarmed by loans taken close to retirement than by ones taken early in a career.
A 401(k) loan isn’t automatically a bad idea. Against high-interest credit card debt or a real short-term need with no cheaper option, prime plus one can be the least expensive money available. What matters is knowing the actual cost rather than treating the loan as free because you’re borrowing from yourself.