What Employers Should Know About 401(k) Loans

Did you know your employees might be able to borrow money from their own 401(k) retirement accounts? It’s called a 401(k) loan, and while it sounds simple, there are a few rules and responsibilities you, as an employer, should know.

What Is a 401(k) Loan?

A 401(k) loan lets employees borrow money from their retirement savings. It’s not free money—it’s a loan they have to pay back with interest. The good news? No taxes or penalties are taken out when the loan starts.

Key facts:

• No credit check needed
• Not reported to credit bureaus
• Fees may apply when the loan is created

Borrowers should consult their Loan Administration Policy/Program for specific loan restrictions and costs.

Is a 401(k) Loan Optional?

Yes! Not every retirement plan allows loans. You’ll need to check your company’s Plan Document to see if it’s an option.

How Much Can Employees Borrow?

The maximum loan amount is:

• 50% of the employee’s vested 401(k) balance
• Or $50,000, whichever is less

Most plans only allow one or two loans at a time. If someone already has a loan, the total borrowed still can’t go over the 50% or $50,000 limit.

How Long Can a 401(k) Loan Last?

Usually, the loan must be paid back within 5 years. If the loan is for buying a home, some plans allow up to 10 or 15 years.

How Do Employees Pay It Back?

Repayment is simple:

• Taken out of the borrower’s paycheck after taxes
• Can be paid off early (unless otherwise specified)
• Payments are reinvested into their 401(k) account

Some providers, like Ascensus, require payments at least every 90 days.

What’s the Interest Rate?

The interest rate is fixed when the loan starts. It’s usually the Prime Rate + 1–2%. The interest goes back into the employee’s account—not to a bank.

What Are Loan Fees?

There are two types:

• Origination fee: Charged when the loan starts
• Maintenance fee: Ongoing cost for managing the loan

These fees are taken from the employee’s account.

What If Payments Are Missed or the Employee Leaves?

If an employee:

• Misses payments: They could default and owe taxes and penalties
• Leaves the company: The loan becomes due immediately

If not paid back, the loan is considered a taxable distribution. If the employee is under 59½, they may also owe a 10% penalty.

What Is a Loan Fund?

This is the money taken out of the 401(k) and loaned to the employee. It’s still part of the plan and earns interest. But here’s the catch: the interest is taxed twice—once when paid and again when withdrawn in retirement.

What About Hardship Withdrawals?

If an employee has an “immediate and heavy financial need”—like medical bills, tuition, or avoiding eviction—they may qualify for a hardship withdrawal. These don’t need to be paid back, but they must try for a loan first. A hardship withdrawal application may be permitted if a loan repayment will cause a significant hardship.

Learn more about hardship withdrawals.

Let’s Talk

There are pros and cons to every decision you make about offering 401(k) loans in your plan. On one hand, offering loans can go a long way toward helping employees feel more comfortable enrolling in your company’s 401(k) plan. On the other hand, 401(k) loans are frequently misused. When utilized incorrectly, they can pose a real threat to someone’s retirement preparedness.

Keep in mind that while loans can be a valued part of your company’s 401(k) plan, they aren’t the most important part. Keep focused on the true benefit of your plan: Helping your employees save for a secure retirement. Need help managing your company’s retirement plan? Contact us—we’re here to make it easy.