Federal rules for readers across the U.S.
401(k) Loan vs Withdrawal: Taxes Explained
By Christian Brinkley. Reviewed October 8, 2026.
Educational information only, not personalized tax, legal, or investment advice. Christian is a licensed insurance agent (NC Life & Health), not a CPA or registered investment adviser. Discuss your own situation with a qualified professional.
How a 401(k) loan works
IRS rules let you borrow up to the lesser of $50,000 or half your vested balance. You repay it within five years through payroll deductions with interest to yourself. Repay it late or leave your job and the balance may become a taxable distribution. Plans can refuse loans, so check your plan documents first.
What a withdrawal really costs
Cashing out is taxed as ordinary income for the year you take it. Add the 10% early-distribution penalty when you are under 59 1/2 and no exception applies. In a 22% bracket with the penalty, nearly a third of the withdrawal disappears to taxes. Hardship withdrawals follow the same tax rules, even when the plan approves them.
When each choice makes sense
Loans fit short-term gaps you are certain you can repay before leaving your job. Withdrawals fit true hardships where repayment is not possible. Neither choice beats building an emergency fund before you need one.
An old loan shrinks your next one
The $50,000 cap isn't always $50,000. The IRS reduces it by the gap between your highest outstanding loan balance in the last 12 months and what you still owe today. Say you borrowed $20,000 last spring and owe $12,000 now. Your new ceiling is $50,000 minus that $8,000 difference, or $42,000, and the 50%-of-vested-balance test still applies on top. Borrowing again and again quietly eats your room. The IRS loan rules walk through the exact math.
Buying a home gets you more time
The five-year repayment clock has one big exception. If you use the loan to buy your principal residence, the plan can stretch repayment beyond five years. Every other purpose has to fit inside five years with payments at least quarterly. Fall behind the schedule and the IRS treats the balance as a distribution, taxed and possibly penalized. Check your plan's loan policy before you count on the longer timeline.
Leaving your job with a loan: the rollover deadline
Most plans demand full repayment soon after you leave. If you can't pay, the unpaid balance becomes a distribution and shows up on Form 1099-R. Here is the part people miss: you can still roll that amount into an IRA or a new employer's plan by the due date of your tax return, extensions included, and avoid the tax hit entirely. Miss that deadline and it's taxable income, plus the 10% penalty if you're under 59 and a half.
| Topic | How they compare |
|---|---|
| Income tax if handled right | 401(k) loan: None when repaid on schedule | 401(k) withdrawal: Taxed as ordinary income |
| 10% early penalty | 401(k) loan: Usually none if repaid | 401(k) withdrawal: Usually applies under 59 1/2 |
| Repayment | 401(k) loan: Required, usually within 5 years | 401(k) withdrawal: None; the money is gone |
Your records checklist
- Ask your plan administrator whether your plan allows loans.
- Borrow only what you can repay through payroll deductions.
- Learn your plan's rule for loans if you leave your job.
- Compare the loan's total cost against a withdrawal first.
Common questions
- What happens to my 401(k) loan if I leave my job?
- Many plans demand the remaining balance soon after you leave. If you cannot repay, the unpaid amount becomes a taxable distribution. You then owe income tax and usually the 10% penalty if under 59 1/2.
- Are hardship withdrawals free from the 10% penalty?
- Usually not. Hardship withdrawals are still taxed as income under 59 1/2. The 10% penalty applies unless a specific exception covers your situation.
- Is the interest I pay on my 401(k) loan tax-deductible?
- No. You repay the loan with after-tax dollars, and the interest goes back into your own account. When you withdraw that money in retirement, it gets taxed again. That double taxation on the interest is one of the hidden costs of borrowing from yourself.
- Can I take a 401(k) loan from an IRA?
- No. IRAs and IRA-based plans like SEPs and SIMPLE IRAs can't offer participant loans at all. Trying to borrow from an IRA counts as a prohibited transaction and can blow up the account's tax status. Loans only exist inside employer plans such as 401(k)s, 403(b)s, and 457(b)s.
Sources and current instructions
Check the tax year and any later updates before acting. These are the primary sources used for this guide.