How does taking a 401k loan affect taxes?

Updated April 13, 2026 by Selena Quintanilla, CTEC

I took a small loan from my 401(k) last year to pay off some debts and get ahead on bills. It seemed like the best option at the time, but now I'm starting to worry about how this will affect my taxes. I'm beginning to think this wasn't the best idea. 

What are the tax implications of taking a 401(k) loan? 

-Lawrence 



Hi, Lawrence! Thank you for taking the time to submit a question! 

Deciding how to access your retirement funds in a pinch is a heavy choice. The good news? A 401(k) loan typically functions like a standard loan and is far less damaging to your long-term wealth than an outright early withdrawal from your retirement plan.
 

What You Need to Know

Regarding how the loan will affect your taxes, the short answer is that it won't. 401(k) loans are not reported on your federal tax return if the loan, including the interest, is paid in full by the due date.

It is important to note, however, that if you default on your loan (i.e., stop making payments), the remaining balance will be reclassified as a “deemed distribution.” At that point, it becomes taxable income and may be subject to the early withdrawal rules, which include a 10% early withdrawal penalty. We discuss this further below.
 

Are there any limits on how much I can borrow from my 401(k)?

While it would be nice to say that the world is your oyster, the sky is the limit, and “go bananas,” there are limits to how much you can borrow from your 401(k). Your loan cannot exceed the lesser of $50,000 or 50% of your vested account balance. And, if you already have an outstanding 401(k) loan, your maximum loan amount must be reduced by the outstanding loan balance of your current loan. This is a specific calculation, so please consult a tax professional or your 401(k) plan sponsor. Those who do not have a large 401(k) balance may borrow up to $10,000 from their 401(k), even if this amount exceeds 50% of the present value of the account. 

Here is an example: 
Lucy was mountain biking when she encountered an unexpected bump on the trail. She went head over heels over the handlebars and broke her arm. Because Lucy did not have health insurance, she needed to pay the cost of repairing her broken arm with cash. To cover the cost, Lucy borrowed $8,000 from her 401(k). At the time she took out the loan, Lucy’s 401(k) had a present value of $12,000, and 50% of the present value is only $6,000. However, because of the $10,000 exception, Lucy was able to borrow $8,000 from her 401(k).
 

Fees and Repayment Timelines

401(k) loans usually come with a variety of fees. Most loans assess a one-time origination fee, in addition to other maintenance and administrative fees. 

To keep the IRS happy, you must generally: 

1. Repay the loan within five years (unless it’s for a primary residence, in which case you can repay it over 10 years).
2. Make level payments at least quarterly.

Failure to repay the loan within five years can trigger a tax bill, as the remaining loan balance will be treated as a taxable deemed distribution. Additionally, if certain conditions are not met, you may also be subject to a federal 10% early withdrawal penalty on your tax return. Something else to consider is that if you leave your job before the loan is repaid, it becomes due sooner. You should review the details of your loan agreement or fee disclosure statement for the terms specific to your situation.
 

Are there special rules for loans taken out due to a qualified disaster?

Qualified individuals (those who sustained an economic loss due to a federal disaster and whose primary home is located within a qualified federally declared disaster zone) can borrow up to the lesser of $100,000 or the full vested benefit amount from their 401(k) account. Unlike regular 401(k) loans, plan participants are not subject to the 50% vested account balance rule. In addition to the increased loan amount, qualified individuals may have an additional year to repay the loan if certain conditions are met. However, your employer’s plan must allow this type of loan; not all 401(k) plans will permit them.
 

What Happens If I Leave My Job?

A common misconception is that you must repay the loan immediately if you leave your employer, and if the remaining balance is not immediately repaid, a deemed distribution will occur. If your 401(k) plan allows, you may be eligible for a qualified plan loan offset, or QPLO. With a qualified plan loan offset, the balance of your 401(k) is reduced by the amount of the remaining loan balance due.

One of the benefits of a qualified plan loan offset is that you can elect to roll over the amount of the loan balance into an IRA or other qualified retirement plan and avoid paying income tax and a possible early withdrawal penalty. You have until the due date of your federal tax return, including extensions, to rollover (deposit) the amount of your 401(k) loan balance into your traditional IRA, another 401(k), or qualified retirement plan.
 

What happens if I need to take a leave of absence from my job?

If you need to take a leave of absence, repayments can be suspended for up to one year. However, the 5-year repayment period cannot be extended, so you will need to either increase the installment amounts for the remaining loan period or make additional catch-up payments. If your leave of absence is due to military service, repayments can be suspended for more than 1 year. Unlike other leave of absences, those on leave due to military service will still have 5 years to repay the loan. The payment period is suspended during the absence and resumes upon their return.
 

What if I Default on the Loan?

Generally, you must be at least 59 1/2 to take a distribution from a retirement plan without paying the additional 10% federal early withdrawal penalty. (Some states also impose their own “early withdrawal penalty.” For example, California imposes a 2.5% early withdrawal penalty). If you do find yourself in the predicament where you default on your loan, the IRS does allow for some "hardship" exceptions where the 10% penalty is waived (though income tax still applies). Common exceptions include:
 

• Medical Expenses: Unreimbursed medical expenses that exceed 7.5% of your Adjusted Gross Income (AGI). 
• The Rule of 55: If you leave or lose your job in or after the year you turn 55.
• Total Disability: If you become permanently and totally disabled.
• Birth or Adoption: Up to $5,000 for qualified expenses related to a new child.

Opting to take out a loan, 401(k), or otherwise, is hardly an easy decision. If you are feeling bad about your situation, cut yourself some slack and remember that while you pay off the loan, you can begin making better decisions toward a more financially secure future.

Sincerely,
Selena