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.
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.