What is the real cost of a 401(k) loan?

The interest goes back into your own account, so it is not the cost. The cost is the market return that the borrowed money does not earn, plus a second tax on the interest.

Is 401(k) loan interest taxed twice?

Only the interest. You pay it with taxed pay, and you pay tax on it again when you withdraw it. In our example, the second tax is $953. You paid no tax when you borrowed the principal, so its repayment is not a second tax.

Is a 401(k) loan less expensive than a personal loan?

On average, in our example, yes. At a steady return of 7%, the 401(k) loan costs $3,691 and the personal loan costs $4,910. Above a steady return of 9.4% a year, the 401(k) loan costs more.

What happens to a 401(k) loan if I lose my job?

Your plan can reduce your account by the unpaid balance. The IRS treats this offset as a distribution. You can roll over the same amount until the due date of your tax return, with extensions. If you do not, it is taxable income, and the 10% tax can apply.

Free 401(k) Loan Calculator: The Real Cost

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Download the spreadsheet Read the essay behind it

Opens in Microsoft Excel, Google Sheets, Apple Numbers, and LibreOffice Calc. To use it in Google Sheets, upload the file to Drive and open it with Sheets.

The default case, from the essay

$20,000 over 5 years, an 8% plan loan, a steady 7% market return

Cost of the 401(k) loan: $3,691
Cost of the personal loan: $4,910
Break-even market return: 9.4%

Above a steady return of 9.4% a year, the 401(k) loan costs more than the personal loan. Below it, the 401(k) loan costs less.

Use the calculator here

Change any number, and the answer changes at once. The calculator uses the same formulas as the spreadsheet, at one steady market return. Enter rates as percentages: for example, type 8 for 8%.

Results appear here.

Loan	Monthly payment	Total interest
401(k) loan
Personal loan
Credit card

Cost of the 401(k) loan, after tax
Of which, market return that you miss
Of which, second tax on the interest
Break-even return against the personal loan
Extra tax if you lose your job that month
Loan limit for your balance

For a bank loan, the cost is the interest. For a 401(k) loan, the interest goes back into your account. So the cost is the market return that the money does not earn, plus a second tax on the interest.

Why the interest is not the cost

With a bank loan, the interest goes to the bank. With a 401(k) loan, the interest goes back into your own account. Thus the interest is not a loss to your household.

The loan has two other costs. First, the borrowed money is not in the market while the loan is open. Second, you pay tax twice on the interest. You pay it with taxed pay, and you pay tax on it again when you withdraw it. The sheet calculates both costs in after-tax dollars.

What is inside

Inputs. The amount, the term, your vested balance, three interest rates, two tax rates, your age, a market return and a month for a job loss.
Compare. The payment and the interest for each loan, and the cost of the 401(k) loan at your return. It also gives the break-even return and the IRS limit for your balance.
Market. The cost of the 401(k) loan at steady returns from -10% to 30% a year, against the two bank loans.
Job loss. The loan balance in each month, and the extra tax if you lose your job then and do not roll over the balance.
Cash-out. What a withdrawal takes from your account if you take the money out instead.
Cheat sheet. The IRS rules, the traps, and the range of costs from the essay.

One return, not 20,000 paths

The essay simulates 20,000 market paths. This worksheet uses one steady return to keep its calculations simple to inspect. Spreadsheets can run simulations without macros, but this worksheet does not.

A steady-return calculation does not show the range of possible market outcomes. At the default inputs, the sheet gives $3,691. The essay reports a simulation average of $3,691.

The sheet does not show the range around the average. At the default inputs, the essay found that the worst 10% of paths cost $9,424 or more. The best 10% gave a gain of $1,194 or more. The Cheat Sheet tab gives these figures.

The job loss test

If you leave your job with a loan open, your plan can reduce your account by the unpaid balance. In the default case, a job loss in month 24 leaves $12,941. If you do not roll over that amount in time, the extra tax at 22% plus 10% is $4,141.

The sheet applies the 10% tax only if you are under 55 at the end of the year that you leave. If you leave your job and the plan offsets the loan, you can roll it over until the due date of that year's tax return. An extension moves the date.

Before you act on it

Ask your plan for its loan rules. A plan does not have to offer loans, and it can set a lower limit than the IRS. Do not decrease your contributions to make the loan payments. The sheet does not include that cost, and it can be larger than the cost of the loan.

Found an error, or think a calculation should work differently? Tell me. Each correction shows its date, the same as in the research reports.

The essay behind this file is the cost of a 401(k) loan is the return you miss. The field guide defines a 401(k) loan and the early withdrawal penalty. Related: a 401(k) can win even after the 10% penalty and the order of operations allocator.

DISCLAIMER · This spreadsheet is an educational tool. It is not financial, tax, investment or legal advice. Each figure is an estimate from inputs that you supply, and the inputs can be wrong. 2 Comma Investor is not a registered investment adviser, broker-dealer or financial planner. Check the facts before you act, and ask a licensed professional. We provide the sheet as is, with no warranty. Full disclosures →

Sources

IRS, Retirement plans FAQs regarding loans, for the loan limit, the five-year term, the payments, default, the plan loan offset and its rollover deadline.
IRS, Retirement topics: tax on early distributions, for the additional 10% tax before age 59½.
IRS, Retirement topics: exceptions to tax on early distributions, for the separation from service at age 55.