Short answer: if your plan offers both, a 401(k) loan is usually the cheaper way to access your money — you borrow up to the lesser of $50,000 or 50% of your vested balance, repay it over up to five years, and pay no tax or penalty as long as you repay on schedule. A withdrawal is permanent: the money leaves your retirement account for good, and before age 59½ it generally costs ordinary income tax plus a 10% additional tax.
How a 401(k) loan works
A 401(k) loan is not a distribution at all. You borrow from your own account and pay it back, with interest, into that same account — so the interest is a payment to yourself, not to a bank. Not every plan offers loans, and a plan may set a lower cap than the IRS allows.
The IRS limit is the lesser of $50,000 or 50% of your vested balance, reduced by your highest outstanding loan balance during the previous 12 months. A worker with a $120,000 vested balance can borrow up to $50,000; a worker with a $40,000 balance, up to $20,000.
Repayment is normally through payroll deductions in substantially equal payments, at least quarterly, over up to five years. A loan used to buy your primary residence can run longer if your plan allows it. The catch is leaving your job: an unpaid balance can become a taxable distribution, and you generally have until your federal tax-return due date to repay it — though some plans demand repayment sooner.
How a withdrawal works — and why it costs more
A withdrawal removes money from your account permanently. It cannot be repaid, and the withdrawn amount stops compounding for the rest of your working life. For traditional (pre-tax) 401(k) money, the withdrawal is taxed as ordinary income in the year you take it. If you are under 59½, a 10% additional tax usually applies on top, unless you qualify for a specific IRS exception.
The IRS recognizes seven safe-harbor reasons, including unreimbursed medical expenses, costs to buy a primary residence, tuition for the next 12 months, payments to prevent eviction or foreclosure, funeral expenses, and certain home repairs after a casualty loss. Credit card debt is not on the list, and qualifying as a hardship does not automatically waive the 10% penalty. Since 2020 there is also no six-month suspension of contributions after a hardship withdrawal. The Internal Revenue Service publishes the current rules for plan loans, hardship distributions, and early-distribution exceptions.
A worked example: $12,000 at age 45
Suppose you are 45, in the 22% federal bracket, and you need $12,000, with a 7.5% plan loan rate as an example:
- Loan: you receive the full $12,000. Repaid monthly over five years, the payment is $240.46 per month, for a total of $14,427.32. The $2,427.32 of interest goes back into your own account. The real cost is subtler: the borrowed money is out of the market while outstanding, so it misses whatever growth it would have earned.
- Withdrawal: you take $12,000 out and keep only $8,160. Federal income tax at 22% takes $2,640, and the 10% penalty takes another $1,200. State income tax, where it applies, would reduce the net further.
- The long-term gap: $12,000 left invested at a 7% average annual return would grow to about $46,436 over 20 years. A withdrawal gives that growth up entirely; a loan gives it up only temporarily, and only on the portion still outstanding.
The loan wins this comparison by a wide margin — as long as you can handle the $240.46 monthly payment and you are not about to leave your job. If either fails, the advantage collapses, because a defaulted loan becomes a taxable distribution with the same penalty problem.
When a withdrawal is the right call
A withdrawal can still be the honest choice in a few situations. If you have already left the job tied to the plan, a loan may no longer be available. If you are 59½ or older, the 10% penalty disappears. And if the expense fits a hardship category, you cannot repay a loan, and no cheaper source of funds exists, a hardship withdrawal is what the rule is for. It should never be a first resort for ordinary debt: paying off credit cards with a penalized withdrawal trades a high-interest problem for a permanent retirement loss. If debt is the real problem, read our guide on 401(k) vs IRA first, then compare the loan route and options outside the plan before touching retirement money.
The decision checklist
Before you take either route, answer five questions: does your plan allow loans, and what is your borrowing limit? Can you afford the payroll deduction for the full term? How secure is your job? Does your expense fit a hardship category? Have you checked a cheaper source of funds first? If the loan answers are all yes, borrow. Otherwise, weigh the withdrawal on its tax cost alone — and take only what you need.
Frequently asked questions
How much can I borrow from my 401(k)?
Up to the lesser of $50,000 or 50% of your vested account balance, reduced by your highest outstanding loan balance during the previous 12 months. Your plan may set a lower cap.
Is a 401(k) loan taxed?
No, not if you repay it on schedule — a qualifying loan is not treated as a distribution, so there is no income tax and no 10% penalty. If you miss payments, leave your job without repaying, or exceed the five-year term, the outstanding balance can be reclassified as a taxable distribution, with the 10% additional tax if you are under 59½.
Does a hardship withdrawal avoid the 10% penalty?
Not automatically. A hardship withdrawal lets you access the money for an approved immediate and heavy need, but it is still taxable as ordinary income, and the 10% penalty still applies before age 59½ unless you separately qualify for an IRS penalty exception. The hardship reason and the penalty exception are two different tests.
Can I take a 401(k) withdrawal to pay off credit card debt?
You can take an ordinary early distribution for any reason your plan permits, but credit card debt is not a hardship safe-harbor reason, so it does not qualify as a hardship withdrawal. You would owe income tax plus the 10% penalty before 59½, and the money would leave your retirement savings permanently — which is why a loan, or a non-retirement payoff strategy, is usually the better first step.