When Jeremy at Generation X Finance wrote The 401k Debit Card: Probably One of the Worst Ideas Ever, I couldn’t have agreed with him more.
What is the 401k Debit Card?
Obtaining a loan against your 401k is nothing new, but in the past it was a bit more difficult and the repayment terms were stricter. Now with the 401k debit card you have a dangerously easy to use program that makes damaging your retirement savings a cinch.
The 401k debit card works just like a bank check card, and allows you to withdraw cash from an ATM or make impulsive buys anywhere that accepts major credit cards.
How Does the 401k Debit Card Work?
If your employer offers a 401k debit card, you simply apply for a loan against your 401k, and deposit the funds into a ReservePlus account. You then receive a debit card which can be used freely.
Rather than having money automatically deducted from your paycheck to repay the loan, which are the terms with a traditional 401k loan, you are sent a bill in the mail and are responsible for paying back the loan. This, of course, raises the risk of not making payments on time. The consequences of defaulting on your loan: heavy tax and early withdrawal penalties for cashing out your 401k.
Why is the 401k Debit Card a Bad Idea?
Particularly during tough economic times like we are now experiencing, and the gloomy outlook of future Social Security payments, under funding retirement planning is a national crisis. The 401k debit card encourages unnecessary borrowing of money that should not be touched until retirement and creates more risk of having to pay hefty fees.
By using retirement money for everyday purchases, or anything other than investing, you are reducing the amount of money and the lifestyle you could enjoy during retirement. This could mean having to work longer and not being able to retire when you plan to, or having to scale back in order to live within your means.
When is the 401k Debit Card a Good Idea?
It is unlikely that the average person would ever have a situation where they would be advised to use a 401k debit card. The only time it would ever make sense to even consider is as a last case scenario for repaying a debt that would otherwise require you to file bankruptcy.
Millionaire Money Habit: Your retirement contributions should not be toyed with. The only changes that should be considered to your 401k funds before retirement is the addition of more money, not taking money out. -RT
4:17 pm on April 9th, 2008 1
What doesn’t make sense to me is that a) This isn’t money you can just access…you have to pay it back and it’s more awkward than credit (unlike a Roth IRA debit card which would allow you to withdraw your contributions but not interest) and b) if you really need to draw on your 401(k), it should probably be in the form of a formal loan.
Debit cards are for paying for things like groceries, Starbucks, and books on Amazon. 401(k) loans (which is what these are of course) are for emergency expenses or one purpose…not frittering.
4:36 pm on April 10th, 2008 2
I agree, Debit is for money you have. Just the very name makes it sound like it’s not a "real" credit card. I hope enough negative publicity gets generated about this to really turn potential users off from it.
Lisa