401(k) Loan Rules: Limits, Repayment, and Default Taxes

A 401(k) loan lets you tap retirement savings without triggering taxes, but the rules for a 401(k) loan are strict: you can borrow the lesser of $50,000 or 50% of your vested balance, you have five years to pay it back, and payments must run at least quarterly in substantially equal installments. Break any of those rules and the IRS treats the unpaid balance as a distribution, which means ordinary income tax on the whole amount and a 10% early-distribution penalty if you’re under 59½. The details below cover the borrowing cap, repayment mechanics, what happens if you leave your job with a balance, and how a missed payment turns into a tax bill.

How Much You Can Borrow

Federal law caps a 401(k) loan at the lesser of $50,000 or half your vested account balance. The $50,000 figure is fixed by statute and has never been adjusted for inflation. A vested balance of $80,000 supports a loan of up to $40,000; a vested balance of $200,000 hits the $50,000 ceiling.¹

One wrinkle catches people off guard. The $50,000 cap is reduced by your highest outstanding loan balance from the plan during the 12 months before the new loan. If you borrowed $30,000 last year and paid it down to $5,000, the IRS still subtracts $30,000 from the ceiling, leaving you eligible for only $20,000. The reduction uses the peak balance, not the current balance, so the timing of a second loan matters.

A floor provision lets participants with smaller accounts borrow up to $10,000 even when that exceeds half the vested balance. Someone with $15,000 vested could borrow $10,000 rather than being held to $7,500. Plans are not required to offer this exception, so check your plan document.¹

Federal law does not limit the number of loans you can carry at once. Each loan must independently meet the repayment rules, and combined balances still cannot exceed the $50,000 or $10,000 limits above.² Many plan documents cap active loans at one or two regardless of what federal law permits.

Higher Limits After a Federally Declared Disaster

Under the SECURE 2.0 Act, participants who live in a federally declared disaster area and have suffered an economic loss from the disaster can borrow up to $100,000 or 100% of the vested balance, whichever is less. The expanded limit applies to loans made during a specified period after the declaration. Plans have to choose to offer this provision; it is not automatic.³

Repayment Rules

The loan must be repaid within five years, with substantially equal payments made at least quarterly. Nearly all plans collect through automatic payroll deductions every pay period, which easily satisfies the quarterly minimum. Loan repayments are not treated as plan contributions, so they don’t eat into your annual contribution limit.⁴

The interest rate must be a “reasonable rate” comparable to a similar commercial loan. Most plans use the prime rate plus one percentage point. Unlike a bank loan, the interest goes back into your own 401(k) account rather than to a lender.⁴

The Exception for Buying a Home

Loans used to purchase your primary residence can run longer than five years. Federal law does not set a specific maximum, so the plan document controls. Some plans allow 10 or 15 years, and a few stretch to 30. The loan still must have level amortization with at least quarterly payments, and the home must be your principal residence, not a rental or vacation property.⁴

What Happens if You Leave Your Job

This is where most 401(k) loans go wrong. When you quit, get laid off, or are fired with a balance outstanding, many plans require you to repay quickly. A common provision requires full repayment by your tax filing deadline, including extensions, for the year you leave.⁴ Some plans accelerate that further and demand payment within 60 or 90 days of separation.

If you can’t repay by the plan’s deadline, the remaining balance is treated as a distribution. The plan reduces your account balance by the unpaid amount, issues a Form 1099-R, and two tax hits follow: the outstanding balance is added to your taxable income for the year, and if you’re under 59½, the 10% early-distribution penalty applies on top of that.⁵

Rolling Over a Plan Loan Offset

When a plan reduces your account to satisfy an unpaid loan on termination, the resulting distribution is called a plan loan offset. You can avoid the tax bill by rolling that amount into an IRA or another eligible retirement plan. A standard plan loan offset gives you 60 days from the distribution date to complete the rollover. A qualified plan loan offset (QPLO), which applies specifically when the offset happens because you left your job or the plan terminated, extends the deadline to your tax filing due date, including extensions, for the year the offset occurs.⁶ That longer window gives you real time to pull the cash together.

Missed Payments and the Cure Period

Missing a single payment does not automatically trigger a taxable distribution. Most plans use a cure period that runs through the end of the calendar quarter following the quarter in which you missed the payment. Miss a payment due in February and you have until June 30 to catch up before the loan is treated as defaulted.⁷

That’s the maximum federal regulations allow, and the plan document has to specifically include a cure period for you to get one. If the plan doesn’t, a missed payment can trigger a deemed distribution right away. Contact your plan administrator as soon as you miss a payment to confirm what applies. Once the cure period expires with the payment still outstanding, the entire loan balance, including accrued interest, becomes a distribution as of the last day of the cure period.⁷

Tax Bill on a Defaulted Loan

When a 401(k) loan fails the repayment rules, the IRS reclassifies the outstanding balance as a deemed distribution. The unpaid balance gets added to gross income for that tax year, and you owe ordinary income tax on the whole amount. If you’re younger than 59½, you also owe a 10% additional tax.⁸ On a $40,000 defaulted loan for someone in the 22% federal bracket, that’s roughly $8,800 in income tax plus a $4,000 penalty, before state taxes.

Your plan administrator reports the deemed distribution on Form 1099-R with distribution code “L” in Box 7, which tells the IRS the distribution came from a loan that failed the legal requirements.⁹ The 10% early-distribution penalty goes on Form 5329 when you file.¹⁰

A detail that surprises people: paying income tax and the penalty on a deemed distribution does not cancel what you owe the plan. The deemed distribution is a distribution only for income tax purposes. Interest continues to accrue, the plan may still require repayment, and any repayments you do make after the deemed distribution increase your tax basis in the plan, which reduces the tax on eventual retirement withdrawals.¹¹

How to Apply

The application is simpler than a bank loan because you’re borrowing your own money. Contact your plan administrator or log into the retirement account portal, specify the dollar amount, choose a repayment period, and pick a payment frequency. The administrator verifies the amount is within your individual limit and confirms the plan allows loans. Not every 401(k) plan includes a loan provision, so confirm yours does before planning around one.¹

If the plan is subject to qualified joint and survivor annuity rules, your spouse must consent in writing before the plan can use your account balance as collateral. That requirement applies mainly to money purchase pension plans or 401(k) plans that have merged in money purchase pension assets. Standard 401(k) profit-sharing plans generally do not require spousal consent unless the plan has specifically elected to be subject to those rules.¹²

Most plans charge a small administrative fee, typically between $25 and $100. Once paperwork is signed, the funds are disbursed to you within a few business days. Payroll deductions start with the next available pay cycle and run automatically until the loan is paid off.

1
Internal Revenue Service. Retirement Topics – Loans
2
Internal Revenue Service. Borrowing Limits for Participants With Multiple Plan Loans
3
Internal Revenue Service. Disaster Relief Frequent Asked Questions – Retirement Plans and IRAs Under the SECURE 2.0 Act of 2022
4
Internal Revenue Service. Retirement Plans FAQs Regarding Loans
5
Internal Revenue Service. Considering a Loan From Your 401(k) Plan?
6
Internal Revenue Service. Plan Loan Offsets
7
Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period
8
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
9
Internal Revenue Service. Instructions for Forms 1099-R and 5498
10
Internal Revenue Service. About Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts
11
GovInfo. Treasury Regulation Section 1.72(p)-1
12
Internal Revenue Service. Spousal Consent Period to Use an Accrued Benefit as Security for Loans