The holidays are in full swing, but for many Americans, the financial reality is already setting in. Credit card balances are climbing, prices remain elevated, and the pressure to manage cash flow intensifies. In these moments, one option often gets dismissed reflexively: borrowing from your 401(k).
But consider this: 401(k) loans have a bad reputation in personal finance circles, and some of that criticism is warranted. Yet here's what the personal finance industrial complex rarely mentions: when you borrow from your 401(k), that money is no longer invested in the market. Which means the fund managers, advisors, and investment companies aren't collecting their annual management fees on those dollars. It's not conspiracy theory; it's simple math. When you see blanket warnings about 401(k) loans being "always terrible," ask yourself: who benefits from that message?
The truth is more nuanced. A strategic, one-time 401(k) loan can be a smart financial move in specific situations. Here are five scenarios where it might make sense:
1. To refinance higher-interest debt
If you're carrying balances at 18-25% interest, a 401(k) loan at 5-7% is mathematically superior, especially when you're paying that interest to yourself, not to a bank. The key word here is "refinance," not "enable." This only works if you've addressed the underlying issue.
2. As a bridge loan for a home down payment
You've found your next home, but your current property hasn't sold yet. Rather than losing your dream house or taking on a high-interest bridge loan from a lender, a short-term 401(k) loan can fill the gap. Once your home sells, you repay the loan and move forward.
3. To avoid predatory lending
Payday loans at 400% APR. Title loans that could cost you your vehicle. When you're facing an emergency (essential car repairs, utility shutoffs, urgent medical expenses) and the alternative is a predatory lender, a 401(k) loan is the far better option. This is genuinely when it serves as the lesser of two evils.
4. To prevent small business failure during a temporary cash flow crisis
If you're self-employed and your business is fundamentally sound but facing a short-term crunch (waiting on receivables, seasonal downturn, unexpected expense), a 401(k) loan can be a lifeline. The key is "temporary" and "viable business." This isn't for propping up something that's failing.
5. For a major, unavoidable expense that would otherwise derail your financial plan
Critical legal fees, essential home repairs, or other significant costs that, if left unaddressed, would create a cascade of larger problems. Sometimes the question isn't "is this ideal?" but rather "what's the least damaging option?"
What you need to know about the mechanics
When you borrow from your 401(k), you're paying yourself back, not a bank or your employer. Interest rates are typically competitive with what you'd get on a secured loan with excellent credit. And here's the interesting part: the interest you pay yourself essentially becomes a fixed-income investment within your 401(k) portfolio.
Two important considerations on that interest: Yes, it ends up being double-taxed (you pay it back with after-tax dollars, then pay taxes again when you withdraw in retirement if you’re using a traditional 401(k)), but the principal is not double-taxed since you weren't taxed when you borrowed it. Also, depending on the size and duration of your loan, you may need to rebalance the rest of your 401(k) if the loan significantly skews your asset allocation too heavily toward fixed income. (just remember to switch it back once the loan is paid off)
These loans don't appear on your credit report, which means you can access them even with poor credit, but also means they won't help you build credit history.
The critical warnings
A 401(k) loan becomes dangerous when it's a band-aid for a chronic problem. If you're taking out the loan to pay off credit cards but haven't addressed why you accumulated that debt in the first place, you're likely to run those balances back up. Then you're stuck with both the loan payment and new debt, and if you end up in a debt management plan or bankruptcy, your 401(k) loan can't be discharged. You're still on the hook.
If you change jobs
This is time-sensitive and crucial: if you leave your employer before repaying your loan, you have options, but you must act quickly:
Many plans now allow you to continue repaying the loan even after leaving, as long as you leave the funds there. You must request this proactively; it's no longer automatic and you’ll have to take steps to set up the payments once your paycheck stops.
Some new employers will accept a loan transfer and continue your payroll deductions. Research this immediately if you're changing jobs.
Even if the loan is treated as a distribution, you may be able to repay some or all of it to a rollover IRA within a certain timeframe to avoid the tax hit and penalty.
Don't let inertia turn your loan into a taxable distribution. If you're changing jobs with an outstanding 401(k) loan, contact us to discuss your options before making any decisions.
The bottom line
A 401(k) loan isn't right for everyone, and it shouldn't become a habit. But in specific, strategic situations, it can be a valuable tool, one that deserves more nuanced consideration than the blanket condemnation it typically receives. The question isn't whether 401(k) loans are inherently good or bad. It's whether this particular loan, in your particular situation, moves you closer to or further from your long-term financial goals.