How Plan Loans Work

By Ian Berger, JD
IRA Analyst

The June 15, 2026 Slott Report outlined the barriers preventing 401(k) and other plan participants from accessing their plan funds while working. The June 24, 2026 article discussed in-plan withdrawals as one way around those barriers. Another way to tap into plan funds while working is to take a plan loan. Company retirement savings plans are allowed to (but not required to) offer loans. According to a recent survey by Vanguard, 82% of 401(k) plans it services allow participants to borrow from their plan. (Loans are not allowed from IRAs, SEP IRA plans, or SIMPLE IRA plans.)

Plan loans are generally limited to the lesser of 50% of your vested account balance or $50,000. Your employer can allow an exception to this rule: If 50% of your vested account balance is less than $10,000, you can still borrow up to $10,000.

Example 1: Cher participates in a 401(k) plan that allows loans. Her vested account balance is $16,000. If the plan doesn’t allow the exception, the most Cher can borrow is $8,000. If the plan allows the exception, she can borrow up to $10,000.

Many plans limit participants to one outstanding loan at a time. But some plans do allow participants to take out a second loan while one remains outstanding. The amount of a second loan is limited by the outstanding balance of the first loan.

Generally, you must repay a plan loan within 5 years. But a loan used to purchase your principal residence can have a longer repayment period, usually 10 or 15 years. Loans must be repaid in substantially equal amounts made at least quarterly. Most plans require repayment through payroll deduction.

Even if your plan offers in-service withdrawals, borrowing from plan assets may be a better option for these reasons:

• Loans are usually available at any age (even before 59½) and for any reason.
• A loan that complies with the maximum dollar limits and the repayment rules is not considered a taxable distribution or subject to penalty, even if taken from a pre-tax account.
• Loans are always repaid to the plan, whereas withdrawals usually cannot be repaid.

However, there’s one significant downside to taking a plan loan. If you leave your employer with an outstanding loan balance that you can’t pay off, your plan account may be offset by the loan balance. That balance is considered a distribution subject to tax and possible penalty. You can avoid the tax and penalty hit if you can come up with the funds to roll over the unpaid balance to an IRA. The rollover deadline is October 15 of the year following the year the offset occurs.

Example 2: Sonny, age 50, terminates employment on July 15, 2026, with a $200,000 401(k) account balance and a $40,000 outstanding loan balance. Sonny doesn’t have the funds to repay the loan balance. On August 15, 2026, the plan offsets his $200,000 account balance by the $40,000 loan balance and distributes $160,000 to him. He rolls over the $160,000 to an IRA within 60 days. Sonny has until October 15, 2027 to find other sources to replace the $40,000 so he can complete a full rollover. Otherwise, he will owe taxes on the $40,000 and a 10% early withdrawal penalty of $4,000 for 2026.

If you have technical questions you would like to have answered, be sure to submit them to mailbag@irahelp.com, to be answered on an upcoming Slott Report Mailbag, published every Thursday.

https://irahelp.com/how-plan-loans-work/