401(k) loan payments are post-tax. When you repay a 401(k) loan through payroll, your employer withholds federal and state income taxes from your gross pay first, and the loan repayment comes out of what’s left. That’s the opposite of how your original contributions to a traditional 401(k) work, where deferrals reduce your taxable income before withholding is calculated.
Why the IRS Treats Repayments as After-Tax
Your elective deferrals into a traditional 401(k) come out of gross pay before income tax is figured. That pre-tax treatment is the core tax benefit of the account. A loan repayment doesn’t get the same treatment because the IRS classifies it as debt service, not as a new retirement contribution. Withholding runs first, then the repayment is deducted.1Internal Revenue Service. Retirement Topics – Loans
This isn’t an oversight. It’s what keeps the loan from being treated as a taxable distribution in the first place. The transaction has to look like real debt, funded by real after-tax income, or the whole balance becomes a withdrawal for tax purposes.
Interest Is After-Tax Too, and It’s Not Deductible
The interest portion of your payment follows the same rule as the principal. It comes out of already-taxed wages, and unlike mortgage interest or student loan interest, 401(k) loan interest is not deductible on your tax return. Both principal and interest flow back into the account using money the IRS has already taken its cut from.1Internal Revenue Service. Retirement Topics – Loans
People often hear that 401(k) loan interest is a good deal because you pay it to yourself instead of a bank. That’s technically true. The interest lands in your own account. What that pitch leaves out is that the interest was paid with after-tax dollars and will be taxed a second time when you eventually withdraw it in retirement.
The Double Taxation Problem
Because repayments go into a pre-tax account using after-tax money, the same dollars end up getting taxed twice: once through payroll withholding when you repay the loan, and again as ordinary income when you take the money out in retirement.
A simple example shows the size of the hit. Say you earn $1,000 and are in the 22% federal bracket. After tax, you have $780 to send toward your loan repayment. That $780 goes back into your 401(k). Decades later, when you withdraw it, you owe income tax on it again. At the same 22% rate, you’d keep about $608 of the original $1,000. If you had contributed that $1,000 pre-tax instead, the full amount would have gone into the account and you’d only pay tax once, at withdrawal.
The interest is subject to the same double hit. You pay it with after-tax wages, and the interest sitting in your account will be taxed again on distribution.
The Roth 401(k) Exception
If the money you borrowed came from a Roth 401(k) source, the second layer of tax disappears. Roth contributions were already made with after-tax dollars, and qualified Roth distributions in retirement come out tax-free. The repayment itself is still after-tax, but there’s no second tax bill waiting at withdrawal. Double taxation on 401(k) loan repayments is fundamentally a traditional 401(k) problem.2Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
Repayments Don’t Count Toward Your Contribution Limit
Loan repayments are not deferrals. They don’t count toward the annual 401(k) contribution limit, which the IRS set at $24,500 for 2026, with an additional $8,000 catch-up contribution for those 50 and older and $11,250 for those 60 through 63.3Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026; IRA Limit Increases to $7,500
This matters because most borrowers feel the squeeze in their take-home pay once repayments start and quietly cut back on regular contributions to make room. If your employer matches a percentage of your contributions, reducing your deferrals means giving up free money. That forgone match doesn’t come back, and it’s usually the biggest hidden cost of the loan.
The Bigger Risk: What Happens If You Can’t Repay
The after-tax repayment structure gets much more expensive if the loan defaults. The most common trigger is a job change. Once you leave your employer, payroll deductions stop and the plan typically requires you to repay the remaining balance on an accelerated schedule. If you can’t, the outstanding balance becomes a deemed distribution: the IRS treats it as though you withdrew that money.4Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Don’t Conform to the Requirements of the Plan Document and IRC Section 72(p)
Two things happen at that point. The full unpaid balance gets added to your taxable income for the year, which can push you into a higher bracket. And if you’re under 59½, the IRS adds a 10% early distribution penalty on top of the ordinary income tax.5Internal Revenue Service. Considering a Loan From Your 401(k) Plan?
There is a way out. You can roll over the outstanding balance into an IRA or another eligible retirement plan by your tax filing deadline (including extensions) for the year the distribution occurred, which neutralizes the tax hit. You do need to come up with the cash from another source, since the money was never actually paid out to you.6Internal Revenue Service. Plan Loan Offsets
The Full Picture
The interest rate on the loan agreement isn’t the real cost. The real cost is the combination of after-tax repayments, double taxation of the principal and interest when they eventually come out of a traditional 401(k), the employer match you may quietly give up while payments are eating your take-home pay, and the tax bomb waiting if you leave your job before the loan is paid off.
None of that makes a 401(k) loan automatically wrong. Borrowing from your own account at plan-set rates can beat a high-rate credit card, and a plan loan won’t hit your credit report even if it defaults. But the after-tax repayment structure is the piece most borrowers don’t see coming, and it’s the reason the sticker rate understates what the loan actually costs you.