The 401k Debit Card: Probably One of the Worst Ideas Ever

I briefly recall hearing about something like this a couple years ago, but I didn’t pay much attention because I didn’t think it would ever come into fruition. Well, I guess I was wrong. The 401k debit card is real, and more companies are beginning to adopt it. As if it wasn’t bad enough that you can treat the equity in your home like a checking account, now there is a push to treat your retirement savings like a checking account. We should be looking at our maximum 401k contribution, not how much we can borrow from it.

The Details of the 401k Debit Card

So, what exactly is this program? Well, it is just what it sounds like–a debit card that is linked to your 401k which allows you to essentially open a line of credit against the amount available to borrow via loan provisions of the plan. That’s right, now people can go shopping for that big screen HDTV and instead of using a credit card or money they have in the bank, they can just swipe their 401k debit card and use those funds.

But wait, there’s more! With a traditional 401k loan, the repayments start automatically to repay the loan through payroll deduction. This means that as long as you’re still employed, you’re guaranteed to make the payments. With the 401k debit card, this is not the case. Instead, the employee is billed directly each month just like a traditional credit card. This means that it is actually possible for someone to miss payments and ultimately default on the loan while still employed. This could result in substantial taxes and penalties for an early withdrawal.

The So-Called Benefits

Some claim that the freedom that this card allows by not tying up funds actually encourages more people to sign up for retirement plans. In my experience, I’d have to say this is not as big of a concern as they make it out to be. Very rarely do I ever encounter someone who refuses to sign up because they don’t want to tie their money up. Most people are aware of the fact that this is a retirement account, and should be used for that purpose unless there is major financial emergency. Even if the money is needed, a traditional loan or even hardship provisions can be used to access the funds.

The other benefit mentioned is that it makes life easier for the human resources department. According to an article at TheStreet.com:

The 401(k) debit-card program means that it [human resources] no longer bears the administrative burden of creating amortization schedules and collecting loan payments. And the program is free for them to adopt: employees pay for the programs administration through an initial sign up fee and interest on their loans.

Well, this is only correct sometimes. Typically only smaller employers are going to be doing any of the administrative work of the 401k plan. Most plan providers now do most of the servicing themselves through the internet, toll-free numbers, or even have a local plan representative on-site or local to work with employees, which takes human resources largely out of the loop. So this “benefit” is not going to affect all employers, and the ones it does will likely only have a few dozen or hundred employees which means they wouldn’t be spending much time administering the plan anyway.

And then you have the argument for loan repayment flexibility:

Generally, with traditional 401(k) loans, employees must pay back their loan within 60 days of leaving a job or be subject to hefty tax and early withdrawal penalties. But with ReservePlus, an employee is able to continue paying the loan off of its initial course — typically five years — regardless of employment.

Again, this is taking a generalization to make it sound better than it is. While it used to be the standard to have to repay your loan in full after leaving the employer, this is becoming less common. Many plans/employers offer the employee an option to request a coupon book so that they can continue to repay the loan with monthly payments even after terminating employment. Of course some plans will still require the loan to be paid off after you leave, but for many people they would have the option to continue with monthly payments even without ReservePlus.

The Obvious Drawbacks

While the benefits of this card are already on shaky ground to begin with, let’s look at the obvious negative aspects of this type of card. The first and most obvious is the ease of accessing these funds. Traditionally, to take a loan against your retirement plan, you had to either fill out a form or call your plan provider to request the loan. Then, it may take a week or more to actually receive the money. With the ReservePlus 401k debit card, people can simply carry their 401k in their wallet or purse and swipe it whenever they want to make a purchase and have instant access to that money.

This is dangerous on so many levels. First, the time that it took to apply for a traditional loan gives people time to think twice about their decision. If they know that they it may take a week or more to get the funds, they are not as likely to take the loan for instant gratification purposes. With that money at their fingertips, it is easy to simply tell yourself that you’ll just use that 401k money now and pay it back right away when the bill comes. This is the same trap people fall into with credit card spending problems where they want to make the purchase right now, and while maybe having good intentions of paying it off right away, find themselves dragging the payments out for months or years.

The second major drawback comes from the way repayment is handled–direct monthly statements to the employee. While ReservePlus cites this as a benefit, I have to disagree. If someone needs to borrow from their retirement plan in the first place, it is probably because they don’t have the money available elsewhere. If that is the case, is it really likely that they are are going to have the money and discipline to continue making the monthly payments? At least with a traditional loan the payments are withheld through payroll, so they have no choice but to make the payments.

Final Thoughts

I think it is clear that this idea is a very bad idea given the state of our social retirement program and the lack of savings by most people. To see real examples, all we have to do is look at the real estate market. With people treating their homes like bank accounts it has helped fuel the housing problems we currently see, and many people are now finding out that they currently can’t get the money back that they borrowed from their equity. To argue that people will make better decisions than this with their retirement funds with access to that money at their fingertips is just foolish in my opinion.

I’d be interested to hear what others think about this idea. I honestly can’t grasp the whole concept and have trouble seeing how this could lead to anything but more problems for people who are trying to save for retirement.

 

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

56 comments
Cranston Snord
Cranston Snord

I like the idea of adding interest into a 401k that I can later turn into a ROTH. Because I can grow the ROTH faster than money in the bank. I also prefer to keep debit card payments off my monthly ledger, as I pay them off every month, but the amounts are always a month in arrears. This would accomplish this.

Credit Card Chaser
Credit Card Chaser

Haha nice job for highlighting this as this is likely one of the dumbest things I have seen in quite some time.

greg
greg

not a bad idea... do you think the card is the reason people are taking money out of their accounts? Taking money from a retirement account should be last resort.. but most 401k's loans and most withdrawals are pre-approved and can be set up online or a simple call. What is available is based on your plan rules. All the card does is make accessing the funds a little easier after processing. Instead of receiving a check and waiting for 7 days the funds will be availble to be removed. To access money you will still be required to go online or call in and process a transaction to sell the securities to gain access to the cash.. it is not a bank account with simple withdrawal whenever capibilities.. calling in to take money out requires to talk to a rep and online will make sure you are aware of the tax implications.... As I stated before retirement accounts should be last resort, but if it is the resort you choose, why not be in this century on options of receiving your money?

Coles Myer
Coles Myer

I think that if you must have good ideas to prosper, but with this kind of offer it will only burden rather than help the consumer.

Brandy
Brandy

A horrible idea. Why on earth would anyone think this is smart. It's scary to think how many people could be hurt by this.

sl00bie
sl00bie

@John

So I assume you're paid to go around and look for negative interweb posts on this topic and "inform" readers as to the "true" (i.e., good) nature of this card. Sounds like a fun job.

Also the next time to do this you may wish to tone your rhetoric down a bit to make it a little less obvious ("you can simply opt to not take out the extra $1,000 and you’ve actually saved some money on your payments!" -- WOW GEE WHIZ I GUESS I WAS WRONG ALL ALONG LOL!).

Eu
Eu

So, John, WHY I need a third party (the escrow people) to pay interest in order to use MY OWN MONEY? If I need to borrow from my 401K I can do it ON MY OWN, PAY INTEREST FOR MYSELF, and put my $5000 in an account service free that has a debit card??

John
John

This is actually a case of the writer of this article being heinously misinformed about what this product actually does.

The way it works is as follows. Say you are hit upon hard times, and you want to take $5,000 loan from your 401(k) because that is what you estimate you will need for the next three months of living expenses while you get back on your feet.

What this product does is escrow that $5,000 into a money markey within the 401(k) (so that it is still earning interest), and has the OPTION to set up a debit card so that you can use the funds at your leisure. It's the same thing as taking the $5,000 all at once, except that you have access to the funds when you need them, and you only take out exactly what you need. Imagine you only needed $4,000 instead of $5,000 - you can simply opt to not take out the extra $1,000 and you've actually saved some money on your payments!

Also, with regards to invoicing the client monthly, this is true, however the loan payment is ACH'd from their bank account automatically, meaning the only way that a payment will be missed is if the bank account goes to zero - and at that point I am sure the participant is not worried about their loan so much as they are worried about bankruptcy.

Educate yourselves. It's not this vile, evil thing that some people assume it to be.

pays to live green
pays to live green

Man, that is one bad idea. The problem is that probably many uninformed people buy into this and don't realize what they are getting into to.

Bill M
Bill M

Who invented this stuff?

Cathy
Cathy

I would like to invite the "dreamer" of this concept to sit behind my desk for a solid year and watch employee's retirement accounts dwindle to nothing.

How would the employer handle stopping deferrals from the participant under the current rules of not partcipating for a 6 month period of time?

I hope this does not become readily available and before adopting this as an option that the current loan trends and withdrawels are reviewed. After the review, I am confident that a responsible leader or CEO would crush this ideal.

Chris Doerfler
Chris Doerfler

Again, this is just another example of how America is a debtor nation. From very young, we are conditioned to spend, spend, spend. Think about college campuses and how they are littered with credit card companies handing out credit cards everywhere.

Another reason why personal finance should be taught in the public school system.

AndyS
AndyS

I have to agree 100% here. I did a similar post on this topic and outrage was what I and most commentors expressed. Looks like laws are coming in place to prevent this financial channel.

Marty
Marty

Let me get this straight... Anyone that uses this 401K debit card will be paying interest and fees to borrow their own money? It would be funny if it wasn't so sad.

It's like I get my friend to save $100 and then I loan him his $100 to him and I charge him interest and fees.

ispf
ispf

Yikes. Combine this and the failing social security system and a lot of people from our generation may never get to retire!!!

Rizzotees.com
Rizzotees.com

This simply cannot be true. This has to be the worst finance invention of all time!

Money Funk
Money Funk

Isn't the idea of a 401(k) to SAVE for retirement. Truly, this is a bad idea!

Andys
Andys

Right on! This is such a bad idea, but like other bad financial ideas this will catch on. I recently wrote about how a company just implemented in and the BS the Chairman was giving about how this was a good idea. Scary!

Bethany
Bethany

Another aspect is that usually you pay fees and interest to borrow someone else's money. With this 401K debit card, you have to pay fees and interest to borrow YOUR OWN money. And generally while you're paying back the loan someone else charged you to borrow from yourself, you're probably paying it off with the money you would have been contributing to the plan. I hope that someday Americans will stop looking at everything as an ATM.

LMJ
LMJ

Well, maybe the price of cat food will drop...

HF Markets
HF Markets

I read your posts with great interest because generally what you are writing about will end up in Europe at some stage. I do hope, however, that this is one of those ideas that is firmly banished from our shores.... no offence!!

Roman
Roman

WOW why would they ever even think this up? People can barely control there credit card? why would you attach there retirement to it?

Matt Sullivan
Matt Sullivan

Nothing will surprise me from now on. I thought Countrywide's VISA credit card to help paydown your mortgage was a dumb idea, but now I have seen it all.

Great Work!

Matt Sullivan, CEO of FreeCreditDusters.com

boomerhater
boomerhater

Unfortunatley, this idea is another mere symptom of a sick economy. Is this idea a way to mortgage out our future to pay off an increasingly problematic consumer debt brought on by sky rocketing medical costs, insurance premiums, housing costs, energy cost etc?

I strongly feel that boomer generation has hosted a feast and now full they are retiring to the den, we are left to clean up the table and dirty dishes. This credit card idea is a sad attempt to apprease those of us left at the table before they slumber.

If for no other reasons than their numbers, the boomer generation had the best opportunity of any to leave this economy in great shape. The US will never again see such a large consumer and tax base to rely upon.

Consider the plight of X:

In X's retirement it is a given by most leading economists that the social security fund will likely be a non-factor or a minimal factor at most. Ouch!

Medical costs and insurance premiums are increasing at a rate comensurate with a space shuttle launch with no slow down in sight. Double ouch!!

Ask other X'ers and you will confirm that the days of the career "pension" is long gone. Statistics have suggested that suggest up to 25% of all boomers at one time in their career lives have worked in an industry that has provided a pension system in one form or another. The same statistics suggest that less that 2% of the generations following the boomers, X included, have had or will ever have career opportunities that provide the same benefit. The answer given to us has been the venerable 401k.

How many of you folks have worked through one of those retirement calculators to determine the required contribution to a 401k to retire comfortably at a certain age? Look closely at the estimated rates of return and compare them to you current portfolio. Good grief, my contributions cannot even cover the percentage of loss I have been experiencing of late. No matter how high my contribution, I will never meet the projections provided in the calculators. To allow a 401k debit card is no different than selling your daughter into prostitution to buy food for dinner. A no win situation at best. But then again, when you consider the rising cost of healthcare, the mortgage crisis and fuel costs, maybe it is already a no win situation.

The current economic situation in our country was caused by a plethora of self centered irresponsible ideas. It cannot be fixed by more of the same.

fishing
fishing

This is freaking sick!

Kris
Kris

Holy moly. I assume the Roth Debit Card has to be next.

akwentoo
akwentoo

Going back to Kristin's point of people not contributing anything to their 401(k) because they can not access their money readily. Wouldn't it be better for these people to contribute something as opposed to nothing? If people are responsible enough to contribute to a 401(k) on a regular basis, they will be responsible enough to not touch it unless absolutely necessary. With no limtis to what they HAVE to take when taking a loan, it leaves the extra money in their account for the future. A lot of plans put a minimum on what has to be taken out so if you need $500 for an emergency, you can take $500 and leave the rest. The reality is that people have to be prepared for an emergency but if those emergencies don't happen, you have money for the future. I think this is a good plan for all the people who do not contribute to a 401(k) plan currently.

Neil
Neil

Cez- While I agree to a point that what you do with your money is your business, you all will soon be asking the rest of us taxpayers to later bail you out of their stupidity a la the sub prime fiasco. So in a way it is my business b/c I don't want my taxes up to bail you out of your stupidity.

mjmcinto
mjmcinto

@Cez...While I agree what people do with their money is their business. However, I also see the writing on the wall. As people spend their retirement savings now with this card instead of leaving it for retirement, they won't have any money left over when they reach retirement age. What really worries (and irks) me is that when this happens, the same people will be holding their hands out, pointing their fingers at everyone else, blaming them, and wanting the government to give them a handout. And guess what...that'll happen. At the expense of all of us who have saved. And since I'm still in my 20's, and already have a net worth in the six figures (which I've really had to work at to get), I just know I'm going to be one of the ones footing the bill for all of the people that act irresponsible and spend all their money now, not caring about the future.

EuLupu
EuLupu

I agree with Cez, why in the world the lenders will not mind their own business instead of attacking people savings? Make YOUR OWN money available not my savings. There is no surprise that credit cards companies are going after people savings, what else do they have to lend and make huge profits? An employer has SOME kind of obligation s regarding its employees 401k, I believe this the main reason why an employer will not let you just freely invest your 401K money in the market and restrict you to specific funds.

Jey Kumar
Jey Kumar

Cez....Yes, it is none of our business or your business.

Do you know a lot of people go through a lot of hardship with this type of credit/debit traps? There are so many organizations that really help people who fall into these traps. Do you think those organizations should not care about these people and mind their own business. We can ignore these things only if we are absolutly selfish.

Jey Kumar
Jey Kumar

The entire credit card scheme looks like tapping money from bad disciplined people or innocent beginners. If you are good disciplined you would have money in savings and would not go for credit cards or this type of debit card.

I am so worried that so many people are going to fall into this trap.

Cez
Cez

Why do you care if it is bad or not. It is available. Let people decide. And if they decide wrong so be it. America is too much into whether we should "allow" things or whether things are "bad" or not. It is none of your business what people do. Mind your own business....If you think it is bad DON"T USE IT!!!!!!

MoneyNing
MoneyNing

Wow this is bad. It's amazing how business are just out to make money even if it means more people will be screwed along the way.

Jane
Jane

My god, I'm glad cards like that aren't available in the UK yet. Out national debt is not far behind the States.

Diako
Diako

This is a great idea... for the lender. Did you catch the bit about "the initial sign-up fee and the interest payments"? If I read that correctly, at least part of the interest will go into the pocket of the lender instead of back into your 401(k), and you have to pay them for the privilege of being able to tap your retirement for pizza and beer.

How in the world did this provision get past lawmakers? And which lawmakers voted for it? They should be run out of town on a rail. Better yet, on foot. And I wouldn't be against an old fashioned tarring and feathering.

Mrs. Micah
Mrs. Micah

I guess it's the HELOC for retirement.

Jerry Kalish
Jerry Kalish

Jeremy:

Excellent article - a link to which is on our blog writing about the same topic.

Sham @ Enhance Life
Sham @ Enhance Life

I also have to agree with the previous comments. I don't think anyone in there right mind would fall for such thing!

Heidi
Heidi

OMG! I work in product developement and portfolio management for a 401(k) provider with an in-house bank. Just last week I was a approached by a company president to look into developing one of these for our firm.

I submitted my recommendation last night. Based on my research: absolutely, positively, an AWFUL idea for the participant. No thank you. The president agreed with my recommendation, but I'm sure it will cross my desk again in the next few years.

These are very attractive to the employer - for the administrative reasons Jeremy mentions in the original post. DB and DC pension companies will offer what their customers (the employer - NOT the employee) demand. It's so sad.

Money Blue Book
Money Blue Book

I completely agree with you on this. People forget that the 401k is a retirement account. They should never ever take the money out for anything but for retirement - it stops the whole compounding process. Making it debit card accessible is a terrible idea.

Jeremy
Jeremy

A rewards card like this is a great idea, but unfortunately not possible. With employer-sponsored plans like 401, 403, and 457s, the are really just salary deferral plans. This means the contributions have to come directly from earnings or through a qualified rollover.

But, this concept could easily be applied to an IRA account. And actually, I'm surprised this isn't already an option through some of the larger discount brokerages (or maybe it is and I'm just not aware of it?) But many brokerage platforms already have decent cash/money market options, and I think a few even offer debit cards for those, so it would be a nice marketing piece to help people bank with their brokerage while earning rewards that go directly into their IRA.

mjmcinto
mjmcinto

@PJ - or how about a 401k Rewards card? I currently have a rewards card that takes 1.4% of my purchases and automatically deposits it into my savings account every 6 months. I might be interested in something similar that did the same thing, except instead of my savings account, went into my 401k.

PJ
PJ

Wow, that is definitely a bad idea. The reverse could be cool though: how about a card that automatically contributes a percentage of your purchase (user tunable!) to your 401k with every swipe. The card company in question would also want to add that percentage invisibly to any authorizations, so the card user can't buy anything unless they can also afford to put the right percentage into their 401k.

David
David

Horrible idea. Maybe if it was limited to first time homebuying it could work.

Chief Family Officer
Chief Family Officer

Wow, that's absolutely HORRIFYING. It's not like people need help going into debt.