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401(k) Loan to Pay Off Debt: Real Cost
IRS rules for 401(k) loans (50% or $50,000, five years), what happens if you leave the job, the computed opportunity cost, and when it beats a 30% APR card.
On this page
- What are the IRS rules for a 401(k) loan?
- What happens if you leave your job with a 401(k) loan?
- When does a 401(k) loan beat a 30% APR card?
- When is a 401(k) loan a trap?
- How does a 401(k) loan compare with the other consolidation tools?
- Frequently asked questions
- Does a 401(k) loan affect my credit score?
- How much can I borrow from my 401(k)?
- Do I pay taxes on a 401(k) loan?
- What is the 10% penalty on a 401(k) loan?
- Is it better to take a 401(k) loan or a hardship withdrawal?
- Can I take a 401(k) loan from an old employer's plan?
Borrowing from a 401(k) looks like the cheapest money anywhere. There is no credit check, the interest goes back into the account, and the payment comes out of a paycheck automatically. The catch is that all of those features are also what make it dangerous. This guide lays out the actual IRS rules, computes what the loan costs against a high-APR card, and names the situations where it turns into a tax bill.
Short answer
A 401(k) loan can beat a 30% APR credit card on interest alone, but the loan must be repaid within five years, is capped at the lesser of 50% of the vested balance or $50,000, and becomes a taxable distribution (plus a 10% additional tax before age 59½) if it is not repaid on schedule. Leaving the job usually accelerates the due date. It is cheapest when the job is stable and the money would otherwise sit at 25% to 30% APR; it is a trap when the job is shaky or the cards get re-run.
Key points
- IRS limit: the lesser of $50,000 or 50% of the vested account balance, with a $10,000 floor plans may allow (26 U.S.C. § 72(p); IRS loan FAQs).
- Repayment must generally finish within five years in substantially equal payments at least quarterly. Only a loan used to buy a principal residence may run longer.
- A missed repayment schedule makes the unpaid balance a deemed distribution: ordinary income tax plus a 10% additional tax if under 59½.
- On a $15,000 balance over five years, a 401(k) loan at 9% costs about $3,683 in interest paid to yourself; the same balance on a 30% card costs about $14,118 paid to the bank.
- The hidden cost is growth: $15,000 out of the market at 7% for five years is roughly $6,038 of missed growth, and the cost climbs when a job change forces a lump-sum payoff.
What are the IRS rules for a 401(k) loan?
Short answer
A plan may allow loans but is not required to. If it does, the most a participant can borrow is the lesser of $50,000 or half of the vested balance, and repayment must generally happen within five years in level payments made at least quarterly. Loans are not hardship withdrawals: no reason has to be given, and the money is not taxed as long as the rules are followed.
The IRS publishes the framework directly, and it is short:
| Rule | What the IRS says | Source |
|---|---|---|
| Maximum loan | Lesser of $50,000 or 50% of the vested balance (the greater of $10,000 or 50% is allowed) | IRS loan FAQs, Q4 |
| Repayment term | Within five years, substantially equal payments at least quarterly | Reg. § 1.72(p)-1, Q&A-3 |
| Exception | A loan to buy a principal residence may run longer than five years | 26 U.S.C. § 72(p)(2)(B)(ii) |
| Multiple loans | Allowed by some plans, but the $50,000 cap is reduced by the highest balance in the prior 12 months | IRS loan FAQs, Q4 and Q8 |
| Spousal consent | A plan may require it for a married participant | IRC § 417(a)(4) |
| IRAs | Loans are never allowed from an IRA, SEP, or SIMPLE IRA | IRS loan FAQs, Q1 |
In plain English
Think of a 401(k) loan as borrowing from a future version of yourself, with the IRS as the referee. The referee does not care why the money is being borrowed. It cares about two things: the amount stays inside the cap, and the payments finish inside five years. Break either one and the loan stops being a loan.
What happens if you leave your job with a 401(k) loan?
Short answer
Most plans make the full balance due shortly after separation. If it is not repaid, the plan reports the unpaid amount as a distribution. Since 2018, a participant has until the federal tax filing deadline for that year, including extensions, to deposit the offset amount into an IRA or new plan and avoid the tax. Without that rollover, the amount is taxed as income, plus 10% if under 59½.
The IRS distinguishes two outcomes, and the difference matters:
| Deemed distribution | Plan loan offset | |
|---|---|---|
| When it happens | Payments stop while still employed and the plan's cure period runs out | Separation from employment or plan termination, and the plan reduces the account by the unpaid loan |
| Tax treatment | Taxed as a distribution, including the 10% additional tax if under 59½ | Taxed the same way unless rolled over |
| Rollover allowed? | No — a deemed distribution cannot be rolled over | Yes — until the tax-filing due date (with extensions) for the year of the offset |
| Source | IRS loan FAQs, Q5 and Q6 | IRS loan FAQs, Q7 |
The number that hurts
Assume $12,000 is still unpaid when a job ends and it is not rolled over. At a 22% federal bracket, the income tax is about $2,640. The 10% additional tax (IRS Topic 558) adds $1,200. That is $3,840 owed at tax time on money that was already spent on the cards, before any state income tax. And the $12,000 is gone from the retirement account permanently.
When does a 401(k) loan beat a 30% APR card?
Short answer
On interest alone, almost always. Over five years, a $15,000 balance at 30% APR costs about $14,118 in interest paid to a bank, while a 401(k) loan at 9% costs about $3,683 in interest paid back into your own account. The loan wins by roughly $10,400 on that comparison. The real question is whether the two hidden costs, lost growth and job risk, eat that gap.
Every figure below is computed with the same amortization math behind our loan calculators: fixed monthly payment, no new charges, no missed payments.
| $15,000 over 60 months | Monthly payment | Total interest | Who receives the interest |
|---|---|---|---|
| Credit card at 30% APR | $485.30 | $14,118.06 | The card issuer |
| 401(k) loan at 9% | $311.38 | $3,682.52 | Your own 401(k) account |
Now the cost that is missing from that table. The $15,000 that left the account is no longer invested. If the account would have earned 7% a year, that money would have grown to about $21,038 over five years, a gain of about $6,038 that does not happen. Loan repayments refill the account over time, so the true opportunity cost is smaller than the full $6,038, but it is real and it compounds for the rest of the participant's working life.
In plain English
A 401(k) loan does not charge you interest so much as it charges you the growth you would have earned. In a flat market that cost is near zero. In a strong market it can cancel most of what was saved by escaping the card. Nobody knows which market is coming, which is why the decision should never rest on the interest comparison alone.
When is a 401(k) loan a trap?
Short answer
It is a trap in four situations: the job is unstable, the cards will be used again after they are paid off, the loan payment squeezes the budget enough to cut retirement contributions, or the employer match is lost because contributions stop. Each one converts a cheap loan into either a tax bill or a permanent hole in retirement savings.
- Taking the loan when a layoff, resignation, or job change is plausible within five years — the balance typically comes due at separation, and the rollover window is the tax-filing deadline, not five years.
- Paying off the cards and leaving them open at the same limits with no plan for spending — the debt returns, and now the 401(k) balance is lower too.
- Stopping or reducing 401(k) contributions to afford the loan payment, which forfeits any employer match in those months — money that cannot be recovered later.
- Borrowing the maximum instead of the amount needed to clear the highest-APR balances, which raises both the opportunity cost and the tax exposure on default.
- Treating the loan as a hardship withdrawal — the two are different, and the withdrawal is taxed immediately with no repayment path.
A budget test that catches most of the risk
Before borrowing, many people ask one question: could this loan be repaid in full from savings or a severance within 60 days if the job ended tomorrow? If the honest answer is no, the loan's cost is not 9%; it is 9% plus a possible 22% to 32% tax hit on whatever is unpaid at that moment.
How does a 401(k) loan compare with the other consolidation tools?
| 401(k) loan | Consolidation loan or balance transfer | |
|---|---|---|
| Credit check | None — it is your money | Hard inquiry; APR depends on credit |
| Interest goes to | Your own account | The lender or card issuer |
| Typical cost | Plan rate (often prime plus 1–2 points) plus lost growth | Disclosed APR plus origination or transfer fee |
| What happens on default | Taxable distribution plus 10% additional tax if under 59½ | Late fees, credit damage, collection — but no tax bill |
| Credit report | Not reported; does not affect utilization or score | Reported; a new installment account appears |
| Bankruptcy protection | Retirement accounts are generally protected in bankruptcy — the loan spends that protection | Unsecured debt can be discharged |
That last row is the one most comparison tables leave out. Money inside a qualified retirement plan is generally shielded from creditors. Pulling it out to pay unsecured debt trades protected money for a payoff of debt that could, in the worst case, have been discharged. Anyone considering both a 401(k) loan and bankruptcy in the same year would generally talk with a bankruptcy attorney first; our debt-relief options guide explains where that line falls.
Frequently asked questions
Does a 401(k) loan affect my credit score?
No. Plan loans are not reported to the credit bureaus, do not require a credit check, and do not appear on a credit report. Paying off cards with the loan can lower the utilization ratio and may help the score, but the loan itself is invisible to scoring models.
How much can I borrow from my 401(k)?
The IRS maximum is the lesser of $50,000 or 50% of the vested account balance, and plans may allow up to $10,000 even when 50% of the balance is less than that. A plan can set lower limits, and a second loan is reduced by the highest outstanding balance during the previous 12 months.
Do I pay taxes on a 401(k) loan?
Not if the loan follows the rules: it stays inside the cap and is repaid within five years in level payments at least quarterly. It becomes taxable only if payments stop and the plan's cure period runs out (a deemed distribution) or if the balance is not repaid or rolled over after leaving the job (a plan loan offset).
What is the 10% penalty on a 401(k) loan?
There is no penalty on a loan that is repaid. If the loan becomes a distribution and the participant is under 59½, IRS Topic 558 applies a 10% additional tax on the taxable portion, on top of ordinary income tax, unless an exception applies.
Is it better to take a 401(k) loan or a hardship withdrawal?
A loan is repaid and is not taxed when the rules are followed; a hardship withdrawal is a permanent, taxable distribution that usually carries the 10% additional tax and requires a demonstrated need. For paying down credit cards, a loan is nearly always the lower-cost path of the two, though both reduce retirement savings.
Can I take a 401(k) loan from an old employer's plan?
Generally no. Most plans only allow loans to current employees, and separation from service is usually the event that makes an existing loan due. Rolling an old plan into a current employer's plan first can restore loan eligibility if the current plan permits loans.
What to do next
- When a consolidation loan actually saves moneyThe full math with the origination fee and disclosed APR, and the offer terms that disqualify a loan.
- Personal loans for bad credit: the honest realityWhat bad-credit loans really cost, the 36% line, and the secured and credit-union alternatives.
- Every debt-relief option, comparedHardship plans, counseling, settlement, and bankruptcy — what each costs and what it can and cannot do.
Sources
This page is based on the following official and authoritative sources. Always check the source itself for the most current rules.
- IRS — Retirement plans FAQs regarding loans (limits, 5-year rule, deemed distribution, plan loan offset)
- IRS — Retirement topics: plan loans
- IRS — Topic no. 558, additional 10% tax on early distributions from retirement plans other than IRAs
- 26 U.S.C. § 72(p) — Loans treated as distributions (Cornell LII)
- CFPB — What is a payday loan? (card APR range and fee-to-APR comparison)
Educational information — not advice
This page provides general educational information about credit, debt, and consumer protections. It is not legal advice, financial advice, or credit repair services, and reading it does not create any professional relationship. Laws, procedures, deadlines, and dollar amounts vary by state and change over time.
For advice about your specific situation, consult a licensed attorney or qualified financial professional. See our full disclaimer.
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