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Borrowing From Yourself

Easy Money?

As the economy nose-dives, a debit card for your 401(k) is stirring up controversy.

Once the debit card program is set up, the employee requests a specific amount—say, $5,000—to be available from the account. Based on the plan’s written loan policy, which determines what sources of funds are available for loans and the order in which investment funds are liquidated, the company’s plan administrator shifts the money from other investments into a money market fund, where it remains until the employee uses the debit card for an ATM withdrawal or a purchase.

Easy enough. But convenience comes with a price. Fees associated with the debit card include a set-up fee of $75, a service fee that averages 2.9 percent, and interest, which is usually at the prime rate (currently 4 percent) plus 1 percent. ATM withdrawals incur a $2 fee for each transaction.

Christian Weller and Virginia Graves, researchers at the nonprofit Center for American Progress in Washington, D.C., calculate that, because of the higher fees, a $5,000 debit card loan paid back over five years “costs about $425 more in the long run than a conventional 401(k) loan.”

Beyond the immediate costs, however, experts agree that people hurting for cash need to keep in mind why they have a 401(k)—to save for retirement.

Pros and Cons of the 401(k) Debit Card

Pros:

  • Spend the amount you want, when you want or need it
  • You’re allowed to pay back more than the minimum owed each month
  • Limits to the amount that can be borrowed may control your spending
  • More flexible withdrawal and payment options for seasonal and union workers than with traditional 401(k) loan

Cons:

  • Any 401(k) withdrawal reduces the amount you’ll have for retirement due to fees and service charges, and the loss of compounding interest or dividends
  • Easy access through debit card may lead to overuse and/or unwise spending
  • Extra fees and higher interest rate may mean higher borrowing costs
  • If you leave your job, or lose it, you may have to pay back the entire loan soon, typically within 90 days
  • Failure to make the minimum required payments can lead to default, and all the money you still owe would be considered a withdrawal subject to income tax
  • Instead of automatic payroll deductions, as with a traditional loan, you must make payments yourself
  • No grace period. Interest starts to accrue as soon as you spend the money.

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