The Unexpected Benefits of Borrowing From Your 401(k)

Many retirement experts warn against borrowing from your 401(k), but for some workers—especially lower-income or first-time savers—the option to take a loan can make all the difference in paying off high-interest debt or whether they join a retirement plan at all.

According to Vanguard, 80% of the defined contribution plans it manages now allow loans, and 13% of savers had an outstanding 401(k) loan at the end of last year. That access can help ease the fear of “locking up” money until age 59½ (when individuals can avoid the 10% early withdrawal penalty) and may even encourage higher contributions. For many, simply knowing the funds are there for a true emergency can make the idea of saving less intimidating.

401(k) Loans and Retirement Savings

A 401(k) loan lets you borrow from your own retirement account and repay the balance, with interest, back into your plan. The Internal Revenue Service (IRS) limits the amount a plan can offer as a loan to either $50,000 or 50% of your vested account balance, whichever is less.

For many savers, the option offers peace of mind. “A loan feature can make 401(k) participation less intimidating, especially for workers hesitant to ‘lock up’ funds,” says Christopher Stroup, founder of Silicon Beach Financial. “Knowing money is accessible in a true emergency can encourage higher contributions.”

Melissa M. Estrada, founder of Fidela Wealth, agrees, noting that 401(k) loans can be particularly impactful for those living paycheck to paycheck. “For many people, especially lower-income families, 59½ or 65 feels so out of reach when you’re dealing with day-to-day bills,” she says. “Having a loan option means that they can still contribute, get the company match if it’s available, and still know they can reach those funds in an emergency.”

Why Loan Access Gets More People to Join Their 401(k)

Vanguard’s research suggests loan features can boost plan participation, especially among hesitant savers. Stroup has seen this firsthand. “For some employees, particularly lower-income or first-time savers, loan access provides peace of mind that boosts initial participation,” he says. “While not a reason to overborrow, it reduces the psychological barrier to contributing more.”

Still, not all advisors see it as a major driver. “It’s not something I’d view as a reason to save more in the first place,” says Filip Telibasa, owner and planner at Benzina Wealth. “In my experience, people increase contributions because of things like a strong employer match or automatic enrollment, not because the loan feature is there.”

The Costs of 401(k) Loans vs. Other Borrowing Options

Compared with credit cards and personal loans, 401(k) loans can look appealing. Stroup notes they typically have lower interest rates than credit cards or personal loans, and the interest you pay goes back into your account. Estrada adds that rates are often prime plus 1%; in fact, according to Vanguard, 73% of its 401(k) loans had interest rates of prime plus 1%, or about 8.5% as of August.

On the other hand, personal loans and credit card rates can get up into the double digits. Plus, there’s no credit check required for 401(k) loans, making them even better for consumers who may not have access to traditional loans.

Still, all three advisors emphasize the hidden cost: lost growth. “The bigger hit is what you don’t see—the missed market growth and compounding while that money is out of the plan,” says Telibasa. Estrada explains that while you pay yourself interest, “you could be earning more than you pay yourself if it were invested in the stock market.”

The Risks You Need to Know Before Borrowing From Your Future

The biggest danger comes if you leave your job before the loan is repaid. “If you leave your job, repayment is often due within months,” Stroup says. If you can’t pay it back, the loan becomes a withdrawal and is subject to taxes and potential penalties.

Separately, Telibasa notes that borrowers often pause contributions during repayment—missing out on matches and time in the market. Estrada echoes this concern and cautions against the “false sense of safety” that can lead to repeated withdrawals and overspending if the loans are abused.

The Bottom Line

A 401(k) loan can be a financial lifeline in the right circumstances: a short-term cash need, stable employment, and no better borrowing option. But advisors agree you should approach them with caution. As Telibasa puts it, it’s best used for “paying off high-interest credit cards when there are no other low-cost borrowing options,” and only with a solid repayment plan.

If you do take one, keep contributing—at least enough to get the full match—and focus on getting the balance back into your account quickly so your retirement savings can start growing again.