Downsides to Borrowing From Your 401(k) to Fund Your Business

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Borrowing from 401(k)If you need short-term or emergency funding, you may be able to take a loan from your 401(k) retirement accounts. Whether you’re taking the loan out as startup financing or paying for a big purchase, make sure to check your plan’s details. If there’s a loan provision in place, you can avoid making an early withdrawal from your 401(k), which would mean you’d have to pay income taxes and a penalty on the money you take out.

Can I Borrow From My 401(k) to Start a Business?

Yes, you can borrow from your 401(k) plan to start a business, but only if your program administrator allows you to take out a loan. It’s important you know how much you can withdraw. According to IRS rules, the maximum amount you can take from your 401(k) plan is 50% of your vested account balance or $50,000, whichever is less.1 So, if you have $80,000, you can take up to $40,000 in a loan.
How to borrow from 401(k)Your plan will tell you how long you have to repay the loan. Generally, you’ll have to pay it off within five years.However, if you’re using the loan to buy a home, you may have longer. Remember that loan payments will include interest, which gets added to your retirement savings account.
If you leave your job and your loan isn’t paid off yet, you’ll still be required to make the remaining payments. And if you’re younger than 59 ½ and don’t pay your loan back in time, the money will be considered an early withdrawal. This means you’ll have to pay a 10% penalty, plus income taxes on the amount you took out.

How to Borrow From 401(k) Accounts

Borrowing from your 401(k)Contact your 401(k) plan administrator to find out how to take out a loan. Generally, you can file an online form to request your loan and receive your payment terms. If you agree with them, you’ll receive your loan in your next pay period.

Things to Consider Before Borrowing From Your 401(k)

Don’t forget to read your 401(k) plan’s fine print. You may also want to think about:
  • What your retirement funds will look like if you take out a loan to start a business, but are not successful.
  • Whether losing out on tax-advantaged growth in your 401(k) is worth getting a short-term loan.
  • If you’ll still be able to make plan contributions if you take out a loan.
  • Making sure you can afford to make loan payments. If not, your loan will count as taxable income and you’ll have to pay a penalty for an early withdrawal.
When you think about it, you may realize you’d be better off getting a low-interest loan from a bank or other financial institution instead.

Alternatives to a 401(k) Loan to Start a Business

Can I borrow from my 401(k) to start a businessMoney you put into your 401(k) helps you save for retirement. If you’re thinking about taking out a loan, it’s important to look at all of your options so you don’t jeopardize your retirement money. Some alternatives to a 401(k) loan include:
Cashing out your 401(k): If you’re 59 ½ or older, you can start taking money out of your 401(k) without paying a penalty. You will, however, have to pay income taxes on the money you take out. This may be better than having to make regular loan payments with interest, though.
Rollovers as Business Startups (ROBS): If you have over $50,000 in your 401(k), you may be able to use the money to invest in your business. While ROBS aren’t a type of loan, you still have to meet certain requirements to get them, like being an employee of the business. Setting up this funding can be complicated and costly because you’ll need to find a provider. This type of financing does affect your business’ structure, so make sure you know how it can impact your company.
Small Business Administration (SBA) loans: The SBA works with lenders to provide loans that can help you start or expand your business. These loans can offer unique benefits, like lower down payments or no collateral. You can visit the SBA's website to find lenders in your area.
401(k) loan to start a businessCredit cards: If you need quick access to money, using a credit card may help your business. Many of them offer cash back and rewards, so you may find additional benefits from using your credit card to fund your business’ needs. However, it’s important to check your interest rate and be sure to pay off your balance so you don’t risk getting into debt and damaging your credit.
Personal loans: If you have a good credit score, you may consider getting a personal loan. These may offer better interest rates and terms than taking out a loan from your 401(k) plan.
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