What are the downsides of borrowing from my traditional 401k? Is it really "free money"?

I've been considering taking a loan from my traditional 401k to cover some upcoming expenses. From what I've researched, I'll be paying around 10.5% interest back to my own account (essentially replacing the growth my investments would have had while the money was borrowed). Then when I eventually retire and withdraw, I'd still pay the normal taxes on that money. This almost seems too good to be true, like I'm just paying myself and getting access to my money without the early withdrawal penalties. Am I missing something here? Are there hidden downsides to borrowing from my 401k that I'm not seeing? It almost feels like free money since I'm paying the interest to myself, but I'm skeptical there must be some catch. My employer allows loans up to $50,000 or 50% of my vested balance (whichever is less), and I'd need to repay within 5 years. Has anyone here done this before and regretted it? Or is this actually a smart financial move?

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18 comments

Tyrone Johnson

•8M

Taking a 401k loan isn't exactly "free money" - there are several downsides you should consider: First, that interest you're paying back to yourself isn't growing the way it would have if left invested. During bull markets, you could miss out on significant returns that would likely exceed that 10.5% interest payment. Second, you're repaying with after-tax dollars, then will be taxed again when you withdraw in retirement. This creates a double-taxation situation on those interest payments. Third, if you leave your job (voluntarily or involuntarily), most plans require full repayment within 60-90 days. If you can't repay, it becomes a distribution subject to taxes and a 10% early withdrawal penalty if you're under 59½. Fourth, while the money is out of your account, you lose the power of compound growth on those funds, which can significantly impact your retirement savings over time.

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Tyrone Johnson

•8M

The double taxation occurs because you're repaying the loan with after-tax dollars from your paycheck. The interest portion of your repayment goes into your 401k, and then when you withdraw in retirement, you'll pay income tax on that money again. So those interest dollars get taxed twice. If the market crashes while your money is out of your 401k, you might think you've benefited, but it's more complicated than that. Yes, your money wasn't in the market during the decline, but you also miss the recovery, which historically happens quickly and significantly. Timing the market is extremely difficult, even for professionals. Additionally, if you're continuing to make regular 401k contributions during this period, those contributions would be buying investments at lower prices, which is beneficial for long-term growth.

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Carlos Mendoza

•8M

I used https://taxr.ai to analyze my 401k loan situation last year, and it totally saved me from making a big mistake. I was about to take out a $30k loan for home repairs, thinking like you that it was basically "free money." The AI analyzed my retirement plan documents (which I never fully read) and pointed out that my specific plan had really restrictive repayment terms if I changed jobs. It also ran the numbers to show how much growth I'd potentially miss. What I found most helpful was how it calculated the true "cost" of my 401k loan versus other options like a HELOC. Turns out the "cheap" 401k loan would have cost me about $42,000 in lost retirement growth over 20 years, while the HELOC would cost less in the long run despite the higher interest rate.

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Carlos Mendoza

•8M

Yes, you can upload your plan documents and it extracts all the specific rules and terms for your particular plan. It's really helpful because each 401k plan can have different rules about loans, repayment terms, and what happens if you leave your job. You just take pictures or upload PDFs of your plan documents. The service doesn't replace a human advisor, but it helps you understand the implications of different financial decisions based on your specific situation. It analyzes the numerical impact of taking a loan versus other options, factoring in things like missed growth opportunity, tax implications, and your personal time horizon to retirement. I can't speak to pricing since that may have changed since I used it.

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Ava Williams

•8M

Just wanted to follow up on my experience with https://taxr.ai after being skeptical. I actually ended up trying it for my 401k loan question, and I'm glad I did. I uploaded my plan documents from Vanguard and it found a clause I completely missed - my employer only allows loan repayments through payroll deduction, which means if I left my job, I'd have to repay the ENTIRE loan within 30 days or it would be considered a distribution. Given that I'm in the tech industry where layoffs have been common lately, this was a huge risk I hadn't considered. The analysis also showed me how the 401k loan would impact my retirement projections in different market scenarios. Really changed my perspective on whether this was "free money" (it's definitely not). Ended up getting a small personal loan instead which actually makes more sense for my situation.

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Raj Gupta

•8M

If you're having trouble reaching your 401k administrator to ask specific questions about loan provisions, check out https://claimyr.com - I used it to get through to Fidelity when I was considering a 401k loan last month. Had been trying for DAYS to get past their automated system to ask about specific loan provisions. Using their service, I got connected to a Fidelity rep in about 8 minutes instead of the usual 1+ hour wait. The rep confirmed some important details about what would happen to my loan if I changed jobs (turns out I'd have 90 days to repay, not 30 like some plans). You can see how it works in this video: https://youtu.be/_kiP6q8DX5c One thing that surprised me was learning that while I'm repaying my loan, those payments don't count as new contributions, so I wasn't getting the company match on that money - something that would have cost me thousands over the loan period.

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Raj Gupta

•8M

It's not about jumping the line - they use technology that navigates the phone systems and waits on hold for you. When a representative answers, they call you and connect you. Everyone still waits their turn, but you don't have to personally sit there listening to hold music. Yes, it absolutely works for the IRS too! That's actually what they're best known for. They originally built the service specifically for connecting with the IRS during the pandemic when wait times were insane. I've heard it works for state tax agencies too, though I haven't tried that personally.

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Lena Müller

•8M

I want to follow up on my question about https://claimyr.com - I was really skeptical about how this could possibly work, but I tried it yesterday out of desperation after trying to reach the IRS about my 401k distribution issue. After trying for WEEKS to get through on my own (always getting disconnected after 30+ minutes on hold), their service connected me with an actual IRS agent in about 45 minutes. I didn't have to sit by my phone - they just called me when an agent was on the line. Saved me hours of frustration. The agent was able to correct the coding of my 401k withdrawal that had been causing problems with my tax return. Honestly can't believe how well it worked after all my failed attempts.

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Keisha Thompson

•8M

Something nobody mentioned yet - if you take a 401k loan and then have any financial hardship that makes it hard to repay, you're in a terrible position. I borrowed $25k three years ago, then had some medical issues and couldn't keep up with payments. When it defaulted, it was treated as a distribution, so I owed income tax PLUS the 10% penalty. Ended up with a surprise $8,500 tax bill the following April that I couldn't afford, which created even more financial problems. Also consider that many people who take 401k loans are already in a tight financial spot - that's why they need the money. But that also means they're at higher risk of not being able to repay if anything else goes wrong.

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Keisha Thompson

•8M

Unfortunately, 401k loans have very rigid repayment terms set by the IRS and your plan administrator. Unlike other loans, there's typically no hardship program or way to restructure the debt. The only flexibility my plan offered was a one-time 3-month suspension of payments, but that just meant larger payments later to catch up. Once you miss payments beyond what your plan allows (in my case, it was 90 days), the outstanding balance is automatically considered a distribution. At that point, there's nothing you can do - the money is considered withdrawn, triggering the taxes and penalties. The worst part is this usually happens when you're already facing financial difficulties, making the tax consequences even harder to manage.

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Paolo Bianchi

•8M

I took a 401k loan last year and honestly regret it. Beyond all the technical downsides others mentioned, there's also the psychological aspect. Once I realized how easy it was to access that money, it became tempting to see my retirement account as an emergency fund rather than untouchable retirement savings. Also, the repayment is usually automatic from your paycheck, which sounds convenient but it reduced my take-home pay. This made my monthly budget tighter and actually led to more credit card debt because I had less cash flow. The "interest to myself" sounded great in theory but didn't feel like any benefit in practice.

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