Do you know why fast food is so popular despite the fact that we all know it’s (a) bad for you (b) is high in calories and (c) has low nutritional value? Mostly because it’s convenient (and ok, sometimes it tastes good) and cheap. Here comes the fast food equivalent in loans, the 401(k) debit card. Yes, now it’s actually possible to go to a casino and conveniently(!) empty your 401(k) account at the ATM machine. This is not a good way to manage your savings.
Reserve Solutions, a unit of New York money manager The Reserve, now offers people a debit card directly tied to their 401(k) plans. How bad is this really? Let me count the ways.
- Withdrawing from your 401(k) plan period is a bad idea. Sure, you are paying yourself back the 8% interest on the money, but you are missing on on compounded returns. What this means is that portfolio funds aren’t there to be invested in the market, can not be invested until you pay back the funds. There is no way to “catch up” on missed investment gains. You may have less money to support yourself after you retire or you will have to work more years before calling it quits.
- With traditional 401(k) loans, there is at least some pain involved in tapping funds, like filling out forms, waiting for the money, etc. The “hassle factor” usually will encourage people to find alternate ways to get back in times of cash crunches. With a debit card, there are no forms and no waiting, therefore no “pain”.
- Discourages the idea of savings and gives people the idea that their 401(k) is a kind of credit card account.
- Allows for multiple accesses to funds - actually there is no limit to the number of withdrawals you can make from your 401(k) using your debit card.
- The funds can be accessed for any reason (like you’re losing at the blackjack tables). With traditional 401(k) plans, you need to have a valid reason, like you are purchasing a home, have medical bills or you are furthering your education.
Terms of the loans (yes, they are LOANS, not early withdrawals) require that with every transaction, you have five years to pay back the money, and the interest rate is as mentioned about 8%, which admittedly is better than a credit card. And unlike fast food, while 401(k) debit loans are convenient, they are hardly cheap - they can lead to financial ruin.
Does anyone have experience with these kinds of cards? Leave a comment!
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1 response so far ↓
1 jq26 // Jul 25, 2008 at 4:54 pm
Just a few little things. I work for a fortune 500 company. Our plan allows us to tap our 401k whenever we want for whatever reason. You don’t have to have any special reason at all. Just have to go online and click a few times. And within 5 days a check appears in your mailbox. The only rule is that you can only take one loan per year (but you can have as many loans as you want outstanding at any given time). So I’m not sure that the last point is accurate- you don’t need to have medical bills or a looming home purchase. This is not unusual from talking to other people.
The other thing to consider I touched on in the post above- there are tax considerations. If buying an appreciating capital asset, a 401k loan is not so bad. You receive the same tax free compounding outside of your 401k and then you pay 0-15% capital gains rates when you liquidate. In a 401k you get tax free compounding but then you pay ordinary marginal rates (as much as 33%).
If paying credit cards off or going on vacation, then 401k loans are a total disaster. Totally agree there.
And just one more point- my 401k gave me no way to short the market over the past year. So I took a 401k loan and invested in SRS and QID ultrashorts. They are up about 20%. Now I have 120% of my balance. But here is the best part. In the interim, the price of my 401k mutual fund shares fell 30%. So now I am buying back those mutual fund shares at 70% the price. All in all, the 30% reduction in price and the 20% increase in loan cash I now have create a net 50% gain during a time when the rest of my 401k plummeted. In other words, it was a backdoor way to hedge this crappy market that my 401k wouldn’t otherwise allow.
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