Borrowing money from a 401(k) plan just got easier; the only thing needed is a 401(k) debit card. When a financial hardship occurs, it's a relief to know one can borrow from their account. But retirement savings are just that: money set aside that's intended to provide income once retired. 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: 401(k) 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 Internal Revenue Service rules individuals need to be aware of if they decide to use this type of card.
All 401(k) 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, a marketer is willing to help. That's how the concept of the 401(k) debit card came about; marketers supplying a service where buyers' demand exists.
Most financial planners would agree that 401(k) 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 401(k) debit cards make it too easy to borrow money from accounts, 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 401(k) 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.
The 401(k) debit card issuer is merely taking advantage of the fact that IRS rules allow for 401(k) loans. With this type of loan, accountholders are borrowing money from their plan and paying back the loan, principal, and interest over time. The most commonly accepted reasons for borrowing against a plan include:
Plan administrators will know the specific repayment rules their employees need to be aware of before deciding to apply for a 401(k) debit card. Typical rules that would apply to this type of arrangement would include:
There can be significant penalties and / or federal income tax consequences if the borrowed money is not placed back in the timeline required by the plan. For example, loans must be paid back in five years or less, and if the borrower fails 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, income taxes may be due on the balance of the loan. Individuals less than 59 1/2 years old may also have to pay an additional 10% tax penalty.
About the Author - 401(k) Debit Card (Last Reviewed on October 19, 2016)