401(k) Loan vs Personal Loan Calculator
401(k) Loans and Personal Loans Explained
Borrowing money often forces a trade-off between speed, cost, and long-term financial consequences. A 401(k) loan lets you tap your retirement savings without a credit check, typically at an attractive interest rate. However, the borrowed funds miss out on potential market growth and must be repaid with after-tax dollars. A personal loan from a bank or online lender keeps your retirement intact but may carry higher interest and affect your credit profile. This calculator weighs these options by estimating the true cost of each approach over a specified term.
Interest and Opportunity Cost
Personal loans charge interest that flows to the lender, whereas 401(k) loan interest is paid back into your account. While that sounds appealing, the borrowed balance no longer earns market returns. The opportunity cost of a 401(k) loan can be approximated with where is the principal, is the expected 401(k) return, is the loan interest, and is the number of periods. This formula highlights how even low-cost borrowing can hinder compounding.
Tax Drag on 401(k) Repayments
When you repay a 401(k) loan, you do so with after-tax income. Later, when funds are withdrawn in retirement, they are taxed again. To model this drag we multiply the total interest paid back into the plan by the marginal tax rate . The tax drag treats the repaid interest as effectively taxed twice, though actual outcomes depend on future tax rates.
Monthly Payment Formula
Both borrowing paths use amortizing loans. The monthly payment is given by where is the monthly rate and is the total number of payments. This equation underpins the cost comparison.
Table of Key Components
| Component | 401(k) Loan | Personal Loan |
|---|---|---|
| Interest recipient | Your retirement account | Lender |
| Opportunity cost | Lost market growth | None |
| Tax treatment | After-tax repayments taxed again at withdrawal | Interest may be tax deductible in limited cases |
Extended Example
Imagine needing $10,000 for a roof repair. Your 401(k) plan allows borrowing at 5% for five years, while a personal loan is available at 9%. You expect your retirement investments to earn 7% annually and face a 22% marginal tax rate. Plugging these values into the calculator shows how much interest would be paid to a lender versus the growth forfeited inside the plan. The table below outlines a sample output.
| Metric | 401(k) Loan | Personal Loan |
|---|---|---|
| Monthly Payment | $188.71 | $207.58 |
| Total Interest | $1,322.60 (returned to 401k) | $2,455.14 |
| Opportunity Cost | $1,128.80 | $0 |
| Tax Drag | $291.00 | $0 |
| Total Cost | $1,419.80 | $2,455.14 |
Interpreting Results
The calculator returns the estimated cost of each borrowing option and labels which is cheaper. A lower interest rate does not automatically make a 401(k) loan the best choice. The lost investment growth could overshadow the savings from paying yourself interest. Conversely, a personal loan may impose higher payments that strain monthly cash flow. Consider the qualitative factors: defaulting on a 401(k) loan triggers taxes and penalties, and leaving your job accelerates repayment. Personal loans risk credit score damage but do not endanger retirement funds.
Strategic Considerations
If your repayment horizon is short and the market outlook uncertain, using a 401(k) loan might be defensible. The opportunity cost shrinks when funds are returned quickly and markets underperform. Moreover, the interest you pay to yourself can somewhat offset the lost growth. Personal loans, despite higher rates, maintain retirement momentum and avoid the double-taxation effect. Use the calculator to run best-case and worst-case scenarios, adjusting expected returns and tax rates to match your circumstances.
Formula Limitations
This tool simplifies many complexities. It assumes constant returns, ignores plan fees, and treats tax drag as a linear function. Some plans may suspend employer matching during loan repayment, increasing opportunity cost. Personal loan interest could be deductible if used for qualifying purposes, a benefit not captured here. Treat the results as a starting point for further analysis rather than definitive guidance.
Long-Term Retirement Impact
Borrowing from retirement today can ripple decades into the future. Even small withdrawals miss out on compounded gains, potentially reducing nest egg value by far more than the nominal loan amount. The compounding equation reminds us that time magnifies early decisions. Weigh whether an expense is urgent enough to justify diverting retirement funds.
Using the Calculator
Enter the loan amount, interest rates, term, expected 401(k) return, and your marginal tax rate. The script computes monthly payments, total interest, opportunity cost, and tax drag. It then highlights which option appears less costly. You can copy the textual result for future reference using the provided button. Experiment with different terms and market return assumptions to see how sensitive the comparison is.
Employer Match Suspension
Some retirement plans halt employer matching while a 401(k) loan is outstanding. Entering the annual match lost field models this hidden cost by multiplying the forfeited match by the loan term and adding it to the 401(k) loan expense. Losing even a few thousand dollars of matching contributions can negate the advantage of a low interest rate.
If your employer pauses matching, consider whether short-term borrowing needs outweigh long-term retirement growth. Paying the loan back quickly restores eligibility for matching and reduces the opportunity cost captured by the calculator.
Job Change and Default Risks
Leaving your job with an outstanding 401(k) loan often triggers accelerated repayment. If you cannot repay promptly, the remaining balance may be treated as a distribution, incurring income tax and an early-withdrawal penalty. Personal loans do not carry this employment risk, though they may require credit checks.
The calculator’s cost comparison does not automatically include penalties, but understanding this scenario is crucial. When evaluating options, think about job stability and whether you could repay the loan quickly if circumstances change.
Credit Implications
A 401(k) loan bypasses credit bureaus, whereas a personal loan may affect your score. Responsible repayment can build credit history, potentially lowering future borrowing costs. Conversely, missed payments harm credit and could raise interest on subsequent loans. The best choice depends on your broader financial goals.
For borrowers with excellent credit, personal loan rates might rival or beat plan loan rates, especially when introductory offers or rate discounts apply. Inputting realistic rates into the calculator reveals when a traditional loan becomes competitive.
Alternatives and Refinancing
Before tapping retirement funds, explore other avenues such as home equity lines, zero-percent balance transfers, or delaying the expense. These options carry their own risks but may preserve tax-advantaged growth. If you already have a 401(k) loan, some plans allow refinancing or increasing payments to shorten the term, reducing opportunity cost.
The calculator can illustrate how making extra payments affects total cost. Simply shorten the term field to simulate accelerated repayment, or adjust interest rates to compare refinancing offers.
Personal Loan Interest Deductibility
Personal loan interest is generally not tax-deductible, but exceptions exist when funds are used for qualifying investments or business expenses. If you can deduct interest, the effective cost of a personal loan drops. The calculator does not account for this deduction; you may approximate it by reducing the personal loan interest rate to reflect the tax benefit.
Consult a tax professional to understand whether your loan qualifies. Misapplying deductions can trigger penalties, so treat any adjustments cautiously.
Related planning tools
Review payment schedules in the 401(k) loan repayment calculator, weigh investment tradeoffs with the 401(k) employer match calculator, and build liquidity cushions through the emergency fund vs debt payoff calculator so your borrowing choice fits a broader financial plan.