A $5,000 401(k) Hardship Withdrawal Can Hand $1,600 to Taxes. A Third of the People Taking One Could Have Borrowed Instead.

If you’re under 59 and a half and about to pull $5,000 out of your 401(k) for an emergency, check one screen first. You may be able to borrow that money from yourself instead of losing a third of it.

Here’s how often people miss that. Vanguard looked at its 401(k) plans and found a record 6% of eligible workers took a hardship withdrawal in 2025, up from 5% the year before. About one-third of them had a 401(k) loan available and no loan balance at all.

The door they skipped was right next to the one they used.

What the withdrawal actually costs

A hardship withdrawal isn’t a loan, so nothing gets paid back. It’s taxed as income, and if you’re under 59 and a half it also gets a 10% additional tax. In the 22% federal bracket, that’s $1,600 of a $5,000 withdrawal before your state takes anything.

Translation: you pay $1,600 to get at your own money.

What the loan costs

Most plans peg the 401(k) loan rate to the prime rate, and prime plus 1% is the most common setting, according to research by economists at Harvard, Yale and Stanford. It’s exactly what Microsoft’s plan charges. The Fed’s latest H.15 release shows prime at 7.00%, so a prime plus 1 loan runs about 8% today.

On $5,000 repaid over two years, that’s about $226 a month and $427 in interest. The interest goes back into your own account. Some plans add small fees on top. Microsoft’s charges $35 to set the loan up and $3.75 a quarter while it’s open.

Compare that with borrowing the same $5,000 elsewhere for two years. At the 11.90% commercial banks charged on 24-month personal loans in the Fed’s August survey, you’d pay about $643 in interest to a bank. At the 22.36% average on credit card accounts that paid interest, about $1,247. Both checks go to someone else.

Not even close. If your plan offers a loan and your job is steady, the loan wins.

Here’s the catch

The loan has one trap, and it’s your job. If your plan calls the balance due when you leave, whatever you haven’t repaid comes out of your account. The IRS calls that a plan loan offset. Some plans are gentler: Microsoft’s lets departing workers keep paying from a bank account if they set it up within 60 days.

You get until your tax filing deadline for that year, extensions included, to put that amount into an IRA or another plan. If you can’t come up with the cash, the unpaid balance gets taxed like a withdrawal, plus the 10% extra if you’re under 59 and a half. So if a layoff looks likely, the withdrawal may be the safer pick.

The other limits are set by the IRS. You can borrow the lesser of $50,000 or half your vested balance, with a $10,000 floor if your plan allows it. A regular loan has to be repaid within five years.

Do this before you file the hardship form

Log in to your plan and open the loans tab. Write down the rate, the fees and the payment for the amount you need.

Then ask your plan one question: what happens to this loan if I leave? If the answer is something you could cover, take the loan. Need the payment math on a different amount or term? Run it through our loan calculator. And if the emergency is bigger than a 401(k) loan can cover, compare your outside options on our best personal loans page.

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