Don't dip into your 401(k) for emergency cash without weighing these costs

By Robert Powell

Here's what you need to know before taking money from your 401(k) or getting a 401(k) loan

Workers with 401(k)s are turning to their retirement accounts when they have a financial emergency.

Imagine you need quick cash to cover an unexpected expense. Maybe the furnace needs replacing, a medical bill arrives out of the blue, or an education expense catches you by surprise.

Now imagine you don't have cash set aside in an emergency fund, your credit cards are tapped out, and you don't have access to an emergency savings account created under SECURE Act 2.0 and offered by some, though not all, employers.

So where might you find the money? Increasingly, workers with 401(k)s are turning to their retirement accounts.

Typically, plan participants have two options: a hardship withdrawal or a 401(k) loan. The key questions: What are the pros and cons of each, and which is better - a loan or a withdrawal?

Mind you, the stakes are high. Saving for retirement is already hard enough. And so when unexpected expenses hit and you need to tap the account designed to pay for lifestyle expenses decades away, well, it's a big deal.

Hardship withdrawals are on the rise. A recent preview of Vanguard's yearly "How America Saves" deep dive into 401(k) data shows that the number of workers taking out money rose "modestly" to 6% in 2025 from 5% the prior year.

Read: The truth behind 401(k) withdrawals

If you withdraw the funds or if you don't pay back the loan, you're pretty much stealing money away from your future self, a future self whose money has to keep pace with the rising cost of living and the possibility of living a long life that needs to be financed with money socked away today.

But if you need the money, then you might as well take the best course of action.

Pros and cons of 401(k) loans

According to experts, 401(k) loans have several advantages over simply withdrawing money from a plan.

For one, the money borrowed isn't taxable as long as the loan is repaid on schedule.

Another advantage is that you're paying interest to yourself rather than to a credit-card company or a bank. A typical interest rate on a 401(k) loan is roughly 1 to 2 percentage points above the prime rate, which in recent years has put most loan rates in the mid- to high-single-digit range, often around 8% to 10%.

"Loans could be better than a withdrawal since you're paying yourself interest, so what you might lose in market gains, you can help cover with some interest," said Nicholas Bunio, a certified financial planner with Retirement Wealth Advisors. "Since this money is no longer being invested."

Read: There's a new record number of 401(k) millionaires - and the Iran conflict will test their discipline

Jeremy Keil, a certified financial planner with Keil Financial Partners, agrees.

"I also prefer a 401(k) loan to a 401(k) or IRA withdrawal because it forces you to pay the money back through your paycheck," he said. "It's a forced savings, forced-discipline situation."

There's also no underwriting or qualification required, and you can access the loan relatively quickly.

In terms of mechanics, Bunio said loans must typically be repaid within five years, though those used for a home purchase may be extended, if the plan allows.

The risks, however, are real. If you leave your job for any reason, the outstanding balance may come due, often within a short window. If you don't repay it, the remaining balance is treated as a taxable distribution.

"If you lose your job or leave on your own, you have to pay this loan back immediately or you get hit with tax penalties," Bunio said. "If you're in an emergency, chances are you won't be able to pay this loan back right away."

And while the loan is outstanding, the borrowed funds are no longer invested, meaning you forgo the potential benefits of compounding.

Loans also come with limits. In many plans, participants can borrow up to the lesser of 50% of their vested account balance or $50,000, subject to plan rules. Some plans also allow a minimum loan of up to $10,000.

Read: Nearly 90% of American adults are vulnerable because they are missing this key document

Pros and cons of 401(k) withdrawals

Experts are quick to point to the downsides of withdrawing money from a 401(k).

For starters, a withdrawal from a traditional pretax 401(k) is a taxable event. You will owe ordinary income tax on the amount taken out and, if you are under age 591/2, a 10% early withdrawal penalty.

It's for that reason Keil favors a loan over a withdrawal. "There's a possibility of paying taxes or penalties if you leave your job and don't repay a loan, but possibility beats certainty," he said.

What's more, the money withdrawn is likely permanently removed from the account, reducing the compounding those dollars might have generated.

Bunio also said withdrawals are unlikely to be repaid.

"A withdrawal more than likely will never be paid back by increasing contributions," he said. "Most people, once they withdraw their money, it's gone forever."

There are, however, some cases where a withdrawal may make sense.

"If you need money because of a hardship, you could avoid the 10% penalty as long as you meet the rules," Keil said. "Make sure to read the IRS rules, talk to your tax preparer and your plan administrator. The IRS says 'may allow,' and you typically need to exhaust other options, like a 401(k) loan, first."

Still, some workers may have no choice.

"I think one has to compare what the alternative is," Bunio said. "If you don't have cash on hand or can't get a loan from a bank and all you have are your 401(k) and IRA, then an emergency withdrawal can make sense."

IRAs do not allow loans. But depending on the purpose, such as paying for college or buying a home, tapping an IRA may be the better option, if you have one. IRS rules allow certain withdrawals to qualify for tax breaks, which could make an IRA more advantageous than a 401(k) in those cases.

Read: These are the top 5 things retirees are worried about right now

Time to rethink your plan

If you're contemplating a 401(k) loan or withdrawal and don't have emergency savings, it may be time to reassess your plan.

"I think they need to rethink their financial plan because that's a huge red flag they're off track," Bunio said. "Unfortunately, that's very common in today's economy."

-Robert Powell

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04-24-26 1315ET