What Are Your Thoughts On 401(k) Debit Cards?

July 22, 2008

Today’s Wall Street Journal had a short article about 409(k) debit cards. Jeremy over at Generation X Finance hates debit cards for 401(k) plans. I agree with Jeremy: it’s probably close to the worst idea ever!

I don’t think we should do anything that encourages people to borrow from their 401(k) plans. That said, the WSJ article did mention a couple of advantages to the debit card:

The debit card aggravates that problem, but it has advantages and disadvantages versus standard 401(k) loans.

For starters, the ReservePlus card is flexible; it can be used multiple times, for any purpose. As with a typical loan, employers set a borrowing limit based on how much you have saved for retirement. By law, the upper limit is generally $50,000 or 50% of your account balance, whichever is less. The approved amount is set aside in a money-market fund and earns tax-deferred interest until you use the card.

With every transaction, you have five years to pay back the money, and the interest rate — now about 8% — may be better than certain people can get elsewhere.

One advantage of a debit card is that if you are laid off or leave the company, there may be no pressure to reconcile the debt immediately. With a typical 401(k) loan, the outstanding amount must be repaid in full, usually within 90 days. Otherwise the loan amount is considered a taxable distribution.

One thing the article doesn’t mention is the cost of borrowing. Usually these loans come with some sort of fee. The interest rate is paid back to the participant’s account (you are essentially paying yourself interest) on an after-tax basis.

Still, despite the advantages, I think 401(k) debit cards and loans are a bad idea. What do you guys think? Have you ever used a 401(k) debit card? If so, what was your experience?

14 responses to What Are Your Thoughts On 401(k) Debit Cards?

  1. I love this idea. Brilliant!

  2. BTW, if folks mess up their 401k, the fed will come to the rescue with 401K TAF (Term Auction Facility:)

  3. I think they’re a terrible idea. Taking a 401(k) loan forces you to consider how much money you really need and to be aware of how much you’ve taken out. I doubt that most people will pay proper attention to how much they’re spending with a debit card. It’s a bit of a hassle…and many people don’t do it with their normal spending anyway.

  4. Average Schlub July 22, 2008 at 1:08 pm

    It seems to fit the growing trend that your 401K investments can be used for current day needs. I realize that sudden healthcare issues or other severe misfortunes can cause financial hardships, but what did people do pre-401K? Could one ever borrow or withdraw from a company pension fund? I don’t know, I’ve never had one but my guess is no.

  5. Roy in Virginia July 22, 2008 at 1:21 pm

    Ah ha! This is just what this country really needs: another way to reduce the retirement funds and portfolios of a populace that already saves too little.

    It isn’t bad enough that “the smartest guys in the room” have greased their own portfolios with obscene salaries, they are cashing in while watching the little guys portfolio go into an eroding death spiral. With a debit card in the hands of the beleaguered little guy the suits continue to rake it in while the debit card user loses his tax deferred benefit. Oh, I am certain that the suits will figure out a way to charge interest!!

  6. Can I have a credit card for future earnings for social security? I know it’s supposed to be for when I can’t work anymore, but what if I need the money now?

    No seriously, one of the stupidest ideas I have heard in a long time. Your 401K is not an ATM. If you need to tap your 401, this means you should cut down your 401 contributions and build up your emergency savings to a higher level.

  7. Wow, I just did a post on this and my thoughts are as follows :

    There more holes in this 401K debit card argument than in Swiss cheese? Firstly borrowing from your 401K is like borrowing against your financial future. It is something you need to carefully think about because of the ramifications like losing the benefit of compounding, tax consequences, transaction fees and loss of any employer match from not contributing. What’s even worse is that if you default and can’t pay back borrowed funds you get hit with high penalties and your credit records get shot. For now, Debit cards mean that folks must have money in the account to withdraw funds. Though, how long before credit cards are introduced with the limit determined based on what’s in your retirement account. In a society where saving and credit is already such a problem, is this something we want to expose our “lower-income and younger people” to?

  8. A 401(k) is not a savings account – it is your retirement savings. I can’t imagine anyone with a modicum of financial literacy thinking this is a good idea. 401(k) loans are paying for something today with your retirement income people! Yikes!

  9. Sounds like another way for the average American to spend money they shouldn’t and buy crap they don’t need.

  10. I think it was created on behalf of unscrupulous members of the financial community who want to make money on extra fees and charges. Awful idea.

  11. Sounds like another lovely “financial product” that will make someone rich and screw up a lot of people who, unfortunately, don’t know better.

  12. This is a very bad idea. Your 401k is not a “piggy bank” and should not be treated like one. Whoever came up wwith this “brilliant” idea will make good money you can bet on that. But for the average American they need to keep as much in their retirement account as they can.

  13. Stupid.

    Stupid.

    Stupid.

    Can’t believe it’s even allowed…

  14. I’ve never been a proponent of putting all of your eggs into one basket, like maxing out your 401(k) just to get the immediate tax break. If you do that at the expense of living today, I think that is a ridiculous strategy, and promotes more problems than it solves. If you find that you aren’t leaving yourself enough post-contribution funds, and you have to raid a 401(k), in turn finding this idea beneficial, I only have one piece of advice: you need to re-prioritize. The whole point of retirement savings is to set aside enough for later so that you are not restricting yourself for today and leaving those funds untouched to compound year-over-year until required in retirement. Otherwise, what is the point at all?