401k Debit Card

Borrowing from your 401k plan just got easier - all you need is a 401k debit card. When a financial hardship comes around, it's a relief to know you can borrow from your 401k plan. But retirement savings are just that - money you've set aside that's intended to provide income after you retire. These two points of view are at the heart of this debit card controversy.

In this article, we're going to discuss a topic that has some financial advisors in an uproar - 401k debit cards. We'll explain how companies are able to issue these cards, as well as the pros and cons associated with this kind of debt. Finally, we're going to run through the IRS rules you need to be aware of if you decide to use this type of card.

401k Debit Cards Explained

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All 401k participants have the ability to borrow against their plan funds, and 20% of all employees take advantage of this opportunity. Where there is a demand for a service, you can bet a marketer is willing to help. That's how the concept of the 401k debit card came about - marketers supplying a service where buyers' demand exists.

Pros and Cons of 401k Debit Cards

Most financial planners would agree that 401k plans are one of the best ways individuals can save for retirement. Employers typically match employee contributions to increase plan participation, and thereby provide employees with an instant return on their investment. At the extreme, companies have eliminated traditional pension plans due to the popularity, and convenience, of this "self-funding" retirement plan.

These same financial planners wince at the thought of employees borrowing against their future to pay for material goods today. These experts believe that 401k debit cards make it too easy to borrow money from plans, arguing that certain individuals really don't understand the long-term implications of their actions.

Issuers of these cards claim that by providing easier access to money placed in a 401k plan they are actually encouraging plan participation. If an employee believes they can access money in their plan in times of need, then they are more likely to place money into their accounts.

While the financial planning community and debit card issuers may not agree on the value of these cards, some of the less controversial pros and cons are summarized below.

Pros of 401k Debit Cards

Applying for a 401k debit card is a simple process, providing easy access to account funds.
Most of the interest you pay on the loan goes right back to your account.
Interest rates are usually very competitive for 401k debit cards when compared to credit cards. Of course, they will include a premium, or margin, which is one of the ways issuing companies profit from these cards.

Cons of 401k Debit Cards

Whether you're taking out a 401k loan, or using a debit card, one of the biggest drawbacks of taking out a this kind of loan is the fact that many plans do not allow you to contribute to your 401k until the loan is completely repaid. If your employer matches your 401k contributions, you're missing-out on some "free" money until the loan is repaid.
The interest rate / expense paid on a 401k loan are not tax deductible.
The term of the loans - five years / 60 months - is relatively short when compared to alternatives such as personal loans.

401k Loans

The 401k debit card issuer is merely taking advantage of the fact that IRS rules allow for 401k loans. With a 401k loan, you're borrowing money from your 401k plan and paying back the loan - principal and interest - over time. The most commonly accepted reasons for borrowing against a plan include:

College Tuition - money can be used to help pay for higher education / college tuition expenses for you, your spouse, or your children.
Home Mortgage - a loan can be used to prevent yourself from eviction from your home due to unpaid mortgage bills or possibly bankruptcy.
Medical Expense - in times of need, funds can be used to pay any un-reimbursed medical expenses that you might have incurred.
First Time Home Buyer - if you're a first-time homebuyer, then a loan can be used to put a down payment on a new home or residence.

401k Loan Rules

Your 401k plan administrator will have repayment rules that you need to be aware of before deciding to apply for a 401k debit card. Typical 401k loan rules that would apply to the debit card include:

Length of Loan - normally the loan term would be five years (60 months) or less.
Loan Maximums - usually the lesser of 50% of the account balance or $50,000.
Program Fees - this may include program setup fees, maintenance fees, cash advance charges, and finance charges.
Interest Rates - 401k debit card issuers will charge cardholders an Annual Percentage Rate (APR) plus a margin.
Repayment -usually 401k loans are repaid through payroll deduction, however, repayment of debit card loans will be made through the issuing company via a monthly invoice.

There can be some significant penalties and / or income tax consequences if you do not pay the money back in the timeline required by the plan. For example, loans must be paid back in five years or less, and if you fail to make payments on the debit card for three consecutive months, then the loan may be viewed as a distribution from the plan. When that occurs, you may be required to pay income taxes on the balance of the loan. Individuals less than 59 1/2 years old may also have to pay a 10% tax penalty.

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