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?