Debit Cards linked to your 401(k)! Danger ahead

From a company press release I saw on a financial news site:

Reserve Management Corp (RMC) is offering a service to employees that allows debit cards to be linked to 401(k) plans, for easy withdrawal of funds. Their Chairman, Bruce R. Bent, justified this offering by saying that they encourage employees to sign up for retirement accounts and that they reduce the dollar amount of loans taken out against them”. Mr. Bent also said in an interview that ” the card program is extremely helpful to attracting lower-income and younger people into the 401(k) plans” and enabling them to “contribute more amounts because they have access to their funds.” Reserve Solutions, the unit that runs the program, takes a 401(k) allocation into a money market account, which earns interest while being available for debit card withdrawals. For example, facing medical expenses totaling several thousand dollars, an account holder could pay smaller initial amounts with debit-card loans instead of taking out one loan up-front to cover the whole amount.

Is it me, or are there more holes in this 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?

The good thing is that the Government is acting fairly quickly on this one by introducing legislation to ban such cards and limit the number of loans 401(k) participants can take out against their accounts. Sen. Kohl said 401(k) plans that offer such a card “send the message that it is OK to use your retirement savings for everyday purchases, despite the fact that the high fees associated with its use will drastically diminish savings.”

Mr. Bent (chairman of RMC) said the debit cards could be controlled to prevent frivolous spending. “What we can do is put filters that would prevent people from shopping at Starbucks or massage parlors” or from withdrawing more than a set amount at any one time from an automated teller machine. [Guess who’ll pay the fees for this!] Traditional loans against 401(k) accounts are less flexible than the debit card-linked loans, he said. “When the person borrows money, they’re forced to take a lump sum, which is stupid and not in the best interests of the person.” And if customers with debit card-linked loans lose jobs, they get more time to repay — up to five years, instead of 90 days, he said.

Do you buy this argument? By making it easy for people to get money out of their 401K accounts, more people will turn to it, especially in tough economic times like now. Their short term relief will turn into long term pain when they cannot afford to retire. If they can’t pay these so called “small” debit card amounts in 90 days, do you think they will be in a better position in 5 years? I argue that they will just keep borrowing until their 401K runs out and the “401K debt collection agency” comes calling.

John Gannon, a senior vice president at the Financial Industry Regulatory Authority said “A 401(k) loan should be a loan of last resort, only used for emergency circumstances or for things like home purchases or college tuition. My concern is that the debit card is only going to increase current consumption. … You’re not going to use a debit card to buy a house.”

Related Posts:
> Why the fall in stock prices was good for your 401K
> Taxes and my Paycheck
> 401K Basics

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