Is It Wise to Borrow From Your 401K?

Your 401(k) balance looks reassuring when money gets tight. It’s your money, after all. But before you borrow from your retirement account, you need to understand what you’re really trading away, and whether the short-term relief is worth the long-term cost.

Here’s what actually happens when you take a 401(k) loan, why financial advisors treat it as a last resort, and what alternatives exist when you need cash now.

 

Can You Take a Loan From Your 401(k)?

Yes, most 401(k) plans allow loans, though not all employers offer this option. If available, you can typically borrow up to 50% of your vested balance or $50,000, whichever is less.
You’re essentially borrowing from yourself and paying yourself back with interest. Sounds reasonable on the surface. The reality is more complicated.

Is it wise to loan from your 401k?

Borrowing from your 401(k) is usually not a wise first option and should be treated as a last resort. While a 401(k) loan may seem safer than an early withdrawal because it avoids immediate taxes and penalties, it still comes with real risks.

How a 401(k) Loan Actually Works

When you take a 401(k) loan, you’re removing money from your investment portfolio. That money stops growing. You repay it through payroll deductions over five years in most cases, and the interest you pay goes back into your own account.

Here’s what makes it different from other loans:

The approval process is simple—no credit check required and your credit score isn’t affected. You’re approved based on your account balance, not your creditworthiness. Repayment happens automatically through your paycheck, which makes it hard to miss payments but also reduces your take-home pay. The interest rate is usually prime rate plus 1-2%, significantly lower than credit cards but higher than what your investments might earn.
The catch most people miss: You’re repaying the loan with after-tax dollars. Then when you withdraw that money in retirement, you’ll pay taxes on it again. It’s the only loan you’ll ever take that gets taxed twice.

The Real Cost of Borrowing From Your Retirement

The immediate impact seems manageable. You get your money, you pay it back, everyone’s happy. But you’re setting off a chain reaction that compounds over time.

Lost Growth Hits Harder Than You Think

Let’s say you borrow $20,000 from your 401(k) and pay it back over five years. During that time, that $20,000 isn’t earning returns in the market. If the market averages 8% annual returns, you’ve missed out on roughly $9,000 in growth, even though you’re paying yourself interest.
Now extend that loss over the next 20 years until retirement. That $9,000 gap grows to over $40,000 in missed retirement savings. One loan, decades of consequences.

The Job Loss Trap

Here’s the risk that catches people off guard: if you leave your job or get laid off, most plans require you to repay the entire loan balance within 60 to 90 days. Can’t do it? The outstanding balance becomes a taxable distribution.

That means you’ll owe income tax on the full amount, plus a 10% early withdrawal penalty if you’re under 59 and a half. A $20,000 loan can suddenly trigger a $7,000 tax bill you weren’t expecting, right when you can least afford it.

Your Contributions Usually Stop

Many plans don’t allow you to continue contributing to your 401(k) while you have an outstanding loan. That means you’re missing out on employer matching contributions too. If your employer matches 50% of your contributions up to 6% of your salary, and you earn $60,000 a year, you’re losing $1,800 annually in free money.

 

When a 401(k) Loan Might Make Sense (Rarely)

Financial advisors generally agree: a 401(k) loan should be your last resort. But there are narrow situations where it might be the least-bad option.
You might consider it if you’re facing a true financial emergency with no other options, you have a stable job with low layoff risk, you can repay it comfortably within the required timeframe, and you’re using it to eliminate high-interest debt that’s costing you more than your investments earn.

Even then, explore every other option first. The risks are real, and they compound over time.

 

Safer Lending Alternatives That Don’t Risk Your Retirement

Before you touch your 401(k), work through these options. One of them might solve your problem without sacrificing your future.

• Build or tap an emergency fund. If you don’t have one yet, start now—even $500 can prevent a crisis. If you have one, use it. That’s what it’s for.
• Consider a personal loan or credit union loan. Interest rates are higher than 401(k) loans, but you’re not derailing your retirement. Credit unions especially offer competitive rates for members with limited credit history.
• Look at a home equity line of credit. If you own a home with equity, a HELOC offers low rates and flexibility. Just be cautious about securing debt against your home.
• Explore hardship programs and community resources. Utility assistance, food banks, medical bill negotiation, and nonprofit credit counseling can address specific needs without loans.
• Consider a structured installment loan. For borrowers with limited credit options, installment loans from responsible lenders can provide cash without touching retirement savings. These loans offer clear terms, fixed payments, and no risk to your 401(k).

Why Wise Loan Can Be a Safer Loan Alternative

When retirement savings are the only option on the table, many borrowers feel trapped. Wise Loan was created to offer another path—one that addresses immediate financial needs without sacrificing long-term security.

Protect Your Future Self

Your 401(k) exists for one reason: to support you when you can no longer work. Every dollar you remove today is a dollar you won’t have in retirement, multiplied by decades of lost growth.

Can you take a loan from your 401(k)? Yes. Is it wise? Almost never. The convenience of easy access doesn’t outweigh the long-term damage to your financial security.

Before you borrow from your future, explore every alternative. Talk to a financial advisor, a credit counselor, or a trusted lender about options that solve your immediate problem without sacrificing your retirement.

Your 70-year-old self will thank you for making the harder choice today.

 

Disclosure:

The recommendations contained in this article are designed for informational purposes only.  Wise Loan does not guarantee the accuracy of the information provided in this article; is not responsible for any errors, omissions, or misrepresentations; and is not responsible for the consequences of any decisions or actions taken as a result of the information provided above.