Wikinvest Wire

Debit cards for your 401k

Wednesday, July 23, 2008

There have been many stories in recent weeks about the sharp increase in the number of workers having to tap their retirement savings in order to make ends meet or help deal with some other sort of emergency.

Now comes word in this story from MarketWatch that some financial institutions are making it easier than ever to "tap" this source of funds during what are very difficult times for many families.

It seems that some finance company is always helping people "tap" something and they always seem to get a healthy cut one way or another. Of course, "tapping" a 401k is a bit different than "tapping" home equity a few years back because it's real money as opposed to ephemeral home equity.

Debit cards are straightforward. You use them for purchases and money is deducted from your bank account. But when the debited account is your 401(k) retirement plan, critics angrily line up to take a swipe at that piece of plastic.

It's not hard to see why. The 401(k) debit card lets you borrow from retirement savings and pay yourself back with interest over time, much as you would with a typical 401(k) loan. Only the card makes it much easier to crack your retirement nest egg; all you do is shop, swipe and sign.

To the advisers, brokers and financial institutions pushing workers to save more for their futures and consider the 401(k) sacred, this debit card is not just objectionable, it's blasphemous.

"We absolutely hate it," says Jean Setzfand, director of financial security at AARP, the organization for people 50 and older. "A 401(k) loan is a last resort."
Reserve Solutions, a unit of New York-based money manager The Reserve, claims on its Web site that its ReservePlus debit card "encourages 'smart borrowing' practices."
Bruce Bent, The Reserve's chairman, says the 401(k) industry and lawmakers have a "gross misunderstanding" of the product and that access to retirement funds can spur employees -- especially lower-income and younger workers -- to save for retirement.
In addition to the finance charges, expect set-up, maintenance and cash-advance fees. Repayments are made with after-tax dollars that will be taxed again when you start drawing on your account, and the interest isn't tax-deductible.

Look closely at that interest rate too. It's based on the prime rate of 5% -- money that returns to your 401(k) account when you repay it. But the other 3% or so goes directly to Reserve Solutions.
That's rich - you get charged three percent to borrow your own money!

Given the recent performance of both the stock market and the economy, withdrawals are now probably at all time highs.

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6 comments: said...

Got to love those enablers...

Troy said...

Repayments are made with after-tax dollars that will be taxed again when you start drawing on your account

Only about 10% of this country is able to understand that 401K loan repayments are essentially repaid with pretax money (the money that was borrowed!) and so are not taxed twice.

The interest you pay yourself, yeah, that is going to be taxed twice.

Russ said...

I'd never tap into my 401(k) before retirement. But I sure would like to tap into my Social Security ASAP.

Edward Harrison said...


Fabulous find. Astounding new innovation. I'm just amazed that this kind of thing is even allowed.


Lord said...

No doubt they are praying their customers will use them to pay their mortgages rather than have to foreclose on more depreciating property, since otherwise it would be protected against collection.

Anonymous said...

I took out the max from my account in 2005.

First, yes, the ENTIRE repayment is taxed, not just the interest. But if you were going to take a loan from somewhere else anyway, then that tax was going to be paid regardless.

But - it's a guaranteed return, resulting in an overall growth to your 401k. At 7%, it's better than any money market, and it's as safe as your job. It's up to you to decide how safe that is.

THIS IS A GOOD DEAL. The ONLY downside (and it's a big one) is that if you leave your job, you must repay the 401k loan IMMEDIATELY. (90 days, but for a $50k loan, that's pretty darn immediate.)

BTW - I used the loan to buy gold coins. It's worked out very, very, very well for me.

This is only to be done if either you are 1) desparate, or 2) have significant other assets that you could use to pay the loan off in the event you lost your job. But if you're in class 2, then borrow away.

But the card? Where you pay someone else interest on YOUR money? That's a very, very bad deal.

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