Many advisors warn against tapping your 401(k), but for some workers—especially lower-income or first-time savers—the option to borrow can be decisive. It can make the difference between paying down high-interest debt or even joining a retirement plan in the first place.
Loan access is common: Vanguard reports that about 80% of the defined-contribution plans it manages allow loans, and roughly 13% of participants had an outstanding 401(k) loan at the end of last year. For many, knowing money is reachable in an emergency reduces the fear of “locking up” funds until age 59½, when you can avoid the 10% early-withdrawal penalty, and can encourage people to start or increase contributions.
How 401(k) Loans Work
A 401(k) loan is borrowing from your own retirement balance and repaying it, with interest, back into your plan. The IRS caps loans at the lesser of $50,000 or 50% of your vested account balance. Because you’re borrowing your own money, plans typically don’t require a credit check, and the interest goes back into your account.
Why Loans Can Boost Participation
Advisors say loans feature lower psychological barriers to saving. Christopher Stroup, founder of Silicon Beach Financial, notes that the ability to access funds in a true emergency can encourage hesitant employees—especially lower-income or first-time savers—to contribute. Melissa M. Estrada of Fidela Wealth adds that for people living paycheck to paycheck, the idea of retirement at 59½ can feel unreachable; loan access lets them keep saving and still feel secure.
Not everyone sees loans as a major motivator. Filip Telibasa of Benzina Wealth says plan enrollment is often driven more by employer matches and automatic enrollment than by loan options.
Costs and Trade-Offs
Compared with credit cards or personal loans, 401(k) loans can look attractive: they often carry lower rates, commonly set at prime plus about 1%, and the interest you pay returns to your account. As Vanguard found, about 73% of its plan loans carried interest at prime plus 1%—roughly 8.5% as of August.
But the hidden cost is lost investment growth. While you repay yourself interest, the money isn’t invested in the market and misses out on compounding gains. Borrowers also sometimes stop contributing during repayment, which can forfeit employer matching and further reduce long-term savings.
Key Risks to Know
The biggest danger is job loss or a job change. Many plans require repayment shortly after employment ends; if you can’t repay, the outstanding balance is treated as a distribution, subject to income tax and possibly the 10% early-withdrawal penalty. Repeated borrowing can also create a false sense of security and fuel overspending.
The Bottom Line
A 401(k) loan can be helpful in specific situations—short-term cash needs, stable employment, and no cheaper borrowing option—especially to pay off high-interest debt. But it’s not risk-free. If you borrow, have a clear repayment plan, keep contributing at least enough to capture any employer match, and return the balance to your account quickly so your retirement savings can resume growing.
