To borrow from your own 401 plan is essentially borrowing from yourself. So the question then becomes, should you make a loan to yourself? The answer is, of course! The fact is that the plan is invested either in stocks, bonds, or money market instruments, and usually a combination of the three. That means that the retirement income reflects how the economy is doing at any one point in time. So how does this affect making a loan to yourself?
An example of borrowing from your retirement plan is important in illustrating why it’s okay to make the loan. Let’s say that Tom wants to open up a business, but for some reason can’t get a loan with reasonable rates. Tom is certainly not going to borrow from his credit cards, as first he doesn’t have enough of a credit line, and second the monthly payment would cripple him. So his only other source is his retirement plan, as he’s exhausted his efforts from friends and family. Tom has $100,000 in his 401k, and he needs $25,000 to begin his business. He realizes that he needs to pay back the loan, and since he still is lucky enough to have a full time job, he doesn’t think this should be a problem. So he makes the loan to himself.
The business he starts is a part-time business, and one in which the money he borrows is going to pay for the tools necessary to begin. The business happens to be a vending machine business, and one in which he can do for a total of about twenty hours per week. Why shouldn’t he borrow from his retirement plan to open his business? Tom feels secure that he can gross around two thousand dollars per month with the business, and he already has his customers lined up. With the money he makes from his business, he can pay off the loan amount and he figures that he’ll have the loan payed off within five years.
Of course, every business is a risk, but nothing ventured, nothing gained is his motto. Tom needs to have another source of retirement income, and relying upon his company that he works for is just as risky as starting a business. His co-workers don’t feel safe at the company, in fact nobody does! If for some reason Tom gets eliminated from his full time job, he will have the option to expand his part time business, so Tom jumps in with both feet secure in the knowledge that he’s done his homework, and feels relatively comfortable that making the leap into his own business is the smartest thing he can do right now to protect his future.
The above is just one example of why it is a good idea to borrow from your own retirement plan. After all, isn’t the retirement plan gambling on how the economy is not only doing currently, but in the future as well? Tom feels he’d rather gamble on himself and his efforts.