Americans saving for retirement are often searching for effective ways to maximize their income during their retirement years.
Over time, individuals may encounter setbacks that affect their financial progress, such as job loss that disrupts contributions, consumer debt that reduces available savings, and medical expenses that require unplanned withdrawals from existing funds.
When these situations occur, the option of borrowing from one’s 401(k) may appear to be a practical source of short‑term liquidity.
Bestselling personal finance author and radio host Dave Ramsey sounds an alarm against taking a loan from a 401(k), noting that doing so reduces retirement growth and increases financial risk.
“Don’t do it,” Ramsey wrote. “It’s not a lifeline. Think of it instead as a heavy weight that could sink your financial future.”
The Internal Revenue Service (IRS) outlines the maximum loan amounts permitted under federal rules and explains the income tax consequences that apply if a loan is not repaid according to the required schedule.
“Loans that exceed the maximum amount or do not follow the required repayment schedule are considered ‘deemed distributions,'” the IRS wrote.
“If the loan repayments are not made at least quarterly, the remaining balance is treated as a distribution that is subject to income tax and may be subject to the 10% early distribution tax,” the government agency added.
Dave Ramsey explains 401(k) loans
A 401(k) loan allows an employee to take funds from an employer‑sponsored retirement plan with the requirement that the borrowed amount is paid back to the account over time with interest.
“No one opens and contributes to a workplace savings account like a 401(k) or a 403(b) expecting to need their hard-earned savings before retirement,” wrote Fidelity Investments. “But if you find you need money, and no other sources are available, your 401(k) could be an option.”
“The key is to keep your eye on the long-term even as you deal with short-term needs, so you can retire when and how you want.”
To access this type of loan, a participant must submit a request through the plan administrator or provider. After the request is reviewed and approved, the borrower signs a loan document that outlines the key terms.
These terms include the loan principal, which is the amount taken from the account, the repayment period that specifies how long the borrower has to return the funds, the interest rate and any associated fees, and any additional conditions required under the plan, according to Ramsey Solutions.
“Since you’re technically borrowing your own money, most 401(k) loans get approved without much hassle and have relatively low interest rates,” Ramsey wrote. “And because no banks or lenders are involved, nobody’s going to check your credit score.”
“Most plans will let you set up automatic repayments through payroll deductions, which means you’ll be seeing less money in your paycheck until the loan is paid off,” Ramsey added. “Those payments — which include principal and interest — will keep going back into your 401(k) until the loan is paid off.”
Dave Ramsey highlights reasons to avoid a 401(k) loan
One reason Ramsey counsels against considering a 401(k) loan is that it can put one’s retirement savings at risk.
“Here’s the deal,” Ramsey wrote. “Your 401(k) is for retirement, not emergencies, debt payoff or vacations. To borrow from your retirement is to steal from your future.”
“For example, if you borrowed as little as $10,000 from your 401(k) at 25 years old, that one choice could cost you dang near $800,000 by the time you’re 65,” Ramsey continued. “It could also require you to stay on the job a lot longer than you want.”
Another disincentive is that a worker can become overly dependent on their employer.
“If you leave your job for whatever reason, you may only have a few months to pay back the entire balance of your 401(k) loan,” Ramsey wrote. “The borrower is a slave to the lender.”
“The bottom line is, debt limits your ability to choose,” he added. “A 401(k) loan can tie you to your job. If you end up desperately wanting to leave or have an exciting job opportunity, you may not be able to do anything about it.”
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A third reason to avoid a 401(k) loan, Ramsey argues, is that one pays taxes on repayments twice.
“If you have a 401(k) loan, the payments you make get no special tax treatment (beyond the moment you get the loan),” Ramsey wrote. “Effectively, they’re taxed twice.”
“That’s because, first, your 401(k) loan repayments are made with after-tax dollars (meaning the money has already been taxed once),” he continued. “Second, you’ll pay taxes on that money again when you make withdrawals in retirement.”
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IRS clarifies maximum 401(k) loan amount
A participant may take a 401(k) loan only up to the lesser of two amounts. The first limit is 50% of the individual’s vested balance, and the second limit is a maximum of $50,000, according to the IRS.
The allowable loan amount is whichever of these two figures is lower.
“An exception to this limit is if 50% of the vested account balance is less than $10,000,” the IRS wrote. “In such case, the participant may borrow up to $10,000. Plans are not required to include this exception.”
The IRS clarifies that plan sponsors may require an employee to repay the full remaining loan balance if employment ends or if the plan itself is discontinued.
“If the employee is unable to repay the loan, then the employer will treat it as a distribution and report it to the IRS on Form 1099-R,” the IRS emphasized.
“The employee can avoid the immediate income tax consequences by rolling over all or part of the loan’s outstanding balance to an IRA or eligible retirement plan by the due date (including extensions) for filing the Federal income tax return for the year in which the loan is treated as a distribution,” the IRS added.
This rollover is reported on Form 5498.
Related: Fidelity, Charles Schwab deliver major message on 401(k)s, IRAs
