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I understand from this, and other related questions, that Muslims are not permitted to charge interest on loans.

This brings up a question for me:

In the U.S. many people have 401(k) retirement plans, and I think IRAs may have a similar provision (and possibly retirement plans in other countries as well), which permit, under certain circumstances, that a person makes a loan to himself, out of his 401(k), then repays the loan, with interest.

Is this scenario permitted in Islam? Interest is being charged--but only to oneself.

EDIT

A similar scenario can occur when a small business owner lends money to his own company. Is he permitted to charge his company (which he owns outright) interest on such a loan?

I don't know if this is a similar enough situation to be covered by the same answer... if not, I can ask a second question.

  • +1 Good question. Any way I got a question, how come the person will charge himself? isn't that interest amount going to be cut down from the total amount after retirement? who will take it? the IRAs or the retirement organizations? – user37 Jul 6 '12 at 17:00
  • @HaLaBi: I'm not sure of all the rules, but I believe one is required to charge interest in this case (I'm not sure how the rate is determined). It's effectively a way to grow your own retirement fund, rather than giving profit to a bank. Your loan payments would be roughly the same--but the interest still belongs to you, you just don't have access to it until you reach retirement age. – Flimzy Jul 6 '12 at 17:01
  • I will try to research it a little. In money related issues every little detail is important. A very tiny details can be the difference between Halal and Haram. – user37 Jul 6 '12 at 17:04
  • This answer provides some of the basic info on these sorts of loans. – Flimzy Jul 6 '12 at 17:04
  • +1 Good question. I don't know; in law here, we consider a corporation like a person. But Islamically, do we accept that or not? That will determine the answer. – ashes999 Jul 6 '12 at 18:58
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Definition

First we should define what exactly interest is:

There are two types of riba discussed by Islamic jurists: an increase in capital without any services provided and risktaking, which is prohibited by the Qur'an, and commodity exchanges in unequal quantities, also prohibited in the Qur'an.

And for practising riba, which was forbidden, and for consuming the people's money illicitly. We have prepared for the disbelievers among them painful retribution. (Quran 4:161)

These excerpts show that the reason for the prohibition of riba is because you are basically cheating people out of their money, you charge them excessively for no extra services provided.

paying interest to yourself

Some do not realize in a 401k plan that the money you have to pay back to you account or "interest" is taxed, and this may be the reason to regard it as haram.

Second, on the interest component, it’s more complicated. Here, the “interest” you’re paying on a retirement plan loan is new money you are putting into your account. You’re using after-tax dollars to make these interest payments/contributions, as opposed to the pre-tax dollars that you might normally put into the plan. When the money comes out in retirement, however, you owe income tax on this “interest” at the same rate as the other pre-tax amounts in the plan. So, in this sense, you “pay tax twice” on the interest.

To summarize it, you are taxed once when you pay the interest, unlike the usual pre-tax payment to the bank from your paycheck. Then you are taxed a second time when you pull the money out of your bank account.

This means that you are being taxed twice on money that should only be taxed once, hence calling it "interest" the government makes a gain off of money you are "giving yourself" they are basically cheating you out of your money, you shouldn’t have to pay taxes on the same money twice.

Conclusion

Jabir said that Muhammad cursed the accepter of usury and its payer, and one who records it, and the two witnesses, and he said: They are all equal

The bank and the government probably do this knowingly, to make people belive they pay money to themselves, when some of the money goes elsewhere. This would make it haram, they all play a part in it including the person paying the money, and this is what the prophet prohibited.

So in conclusion, not all the interest goes to yourself, you're being taxed on the interest so part of it goes elsewhere, most likely the government, and in rotation, eventually the government returns the money to the bank when it gives loans, turning "a payment to yourself" back to a regular old interest payment to the bank.

sources: wikipedia-Riba, 401k blog

  • 1
    This misses a few important points. First, on the interest being taxed twice; that may be technically true, but practically immaterial. If you were to borrow money from some other source, you would pay taxes on your income before you pay the interest, then the recipient of the interest would also pay taxes on their income. You're only doing the same thing; so it's not like there's some magical "double interest" being paid. Second, "turning 'a payment to yourself' back into a regular old interest payment to the bank" doesn't really make sense. Sure the bank earns money, but generally...(cont) – Flimzy Jul 30 '12 at 2:11
  • ...in the form of administration fees, not interest. So while the bank may make money from you lending yourself money, they are not earning interest on the transaction. – Flimzy Jul 30 '12 at 2:12
  • The explanation of 401 loan 'interest' as being haram is wrong. You don't pay double tax if you think critically. When you are paying off the 401K loan, you are using after tax money, but don't forget the 401k loan money that you are using, you did not pay tax on that, so the so called 'double tax' is not true, as you are using your 401k loan money without paying tax in the first place. Consider the second tax is the tax on the money that you used without paying the tax that time. – user2725 Jun 27 '13 at 19:59

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