A 50-year-old I will call Sarah has $750,000 in her 401(k), a daughter starting an expensive nursing program, and a kitchen untouched since 1998. Her plan administrator says she can borrow $50,000 at roughly 8%, with interest paid back to her own account. Against a 21% credit card or a HELOC, it sounds obvious.
She is not alone. Fidelity data shows 19.5% of 401(k) savers carry a loan balance, jumping to 25.9% for Gen X. With the personal savings rate down to 3.7% from 6.2% two years ago, the temptation is structural.
I would tell Sarah to leave the money where it is. Here is the math she is not seeing.
The real cost is forgone compounding
Sarah compares 8% she pays herself to 21% on a credit card. The real cost is the return that $50,000 would have earned inside the plan over 17 years until age 67.
SPDR S&P 500 ETF Trust (NYSEARCA:SPY), the most common S&P 500 proxy in 401(k) menus, has returned 80% over five years and 259% over ten. Assume 10% annualized forward return. $50,000 left in the account compounds to roughly $253,000 by age 67.
If she takes the loan, repays principal plus interest of about $60,000 over five years, and lets that sit until 67, she ends with closer to $188,000. The gap is about $65,000, even though she repaid every dollar on time to herself.
The contribution trap
A borrower with a five-year repayment of roughly $12,000 a year discovers her take-home is squeezed and quietly cuts her 401(k) deferral. Cut contributions by $8,000 a year and a typical 4% employer match disappears, since most plans only match what you defer.
Over five years that is roughly $55,000 of contributions plus match that never enter the account. Compounded to 67, the foregone balance is around $110,000. Even if Sarah cuts her deferral by half that, the damage easily clears $50,000.
Add the two leaks together and the “cheap” loan has quietly cost her north of $100,000 by retirement. Clark Howard’s framing is cleanest: “401k loans are best used only for a catastrophe, a catastrophic circumstance that there’s no other way to pay for, not a temporary cash flow problem.”
Two landmines that turn a loan into a distribution
Sarah is 50, below the Rule of 55 cutoff. If she loses her job before fully repaying, most plans demand the outstanding balance by the following October’s tax filing deadline. Miss it, and the unpaid amount becomes a deemed distribution, taxed as ordinary income and hit with the 10% federal penalty.
The second landmine is double taxation on interest. She repays the loan with after-tax dollars, then pays ordinary income tax again when she withdraws that money in retirement. It is not enormous on a single loan, but it is real.
What to do instead
- Reprice the actual borrowing decision. A home equity line at current rates, even at 8% to 9%, leaves her 401(k) compounding untouched. The deductibility of HELOC interest used for home improvements can drop the effective rate further. The right comparison is the HELOC against the 21% card and the 401(k) loan together.
- Protect the catch-up first. The 2026 employee deferral limit is $24,500, with an $8,000 catch-up once she turns 50. If her 2025 wages exceeded $150,000, that catch-up must land in a Roth 401(k) under the SECURE 2.0 rule effective January. Do not let a loan repayment crowd out the catch-up. That bucket is the most tax-advantaged dollar she will contribute this decade.
- Park the emergency fund where it earns. The FDIC national average 12-month CD is 1.65%, but top online banks routinely pay 3 to 5 times. A six-month buffer in a high-yield account is the single most effective vaccine against needing a 401(k) loan.
Sarah’s $50,000 problem is real. The 401(k) loan solves it for 60 months and bills her for the next 17 years. Better answers exist.
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