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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.

When the gas tank is empty, the mortgage is due, or your spouse’s job has just been cut, it’s natural to search everywhere for the cash to keep up financially. That’s when tapping into your retirement nest egg can become increasingly tempting—especially when it’s as easy as swiping a card at the cash register. And that’s exactly what the 401(k) debit card will let you do.

But not without some controversy.

In recent weeks, financial industry overseers have warned consumers that using the debit card can result in paying excessive fees, spending retirement savings on unnecessary expenses, and draining accounts intended to be a retirement safety net. The U.S. Senate Special Committee on Aging has also discussed the issue in hearings, and two senators have introduced legislation to prohibit employers from offering the cards to employees who have 401(k) accounts.

But why such a strong reaction against this particular way of borrowing against your 401(k) funds at a time when the economy is in turmoil, banks are tightening credit, and your home equity is rapidly deflating? 

“It’s a way of jeopardizing your retirement,” says Roberto Baerga, president of Consumer Credit Counseling Service of Puerto Rico. “I don’t agree with [using] a card that will allow you to take out money any time you want to.”

And Yanira Cruz, president and CEO of the National Hispanic Council on Aging, says that some Hispanics may be misled about the long-term effects of using the card. “It’s very tempting for a 40-year-old to take money out of a 401(k) to address an immediate need, not thinking of the consequences 10 years from now, or 15, 20 years from now.”

Pam and Steve Villarreal of Plano, Texas, know this all too well. The couple, now in their 40s, took out a two-year $6,000 loan from their 401(k) account for a down payment on a home some 15 years ago. Now, looking back on their decision, they wish they’d “waited a couple of years and saved up the money instead of borrowing,” says Pam.

They realize that while they were paying back the loan, they lost the benefit of both the investment returns on the borrowed amount, and, because their plan did not allow them to contribute to their account during the payoff period, the tax deferral of normal 401(k) contributions. Plus, “if you have the match [from your employer], you have the potential to lose more,” Pam says. “Your employer is not going to match your loan payment.”

Nearly 90 percent of 401(k) plans allow employees to take loans from their plans, according to the Profit-Sharing Council of America. Traditionally, the loans must be paid back to the account, with interest, in five years and by payroll deduction. The maximum the employee can borrow is $50,000 or half of the savings vested in the 401(k) account, whichever is lower. The employer may restrict use of the funds to, for example, emergencies such as a medical crisis or to avoid eviction.

The 401(k) debit cards, introduced in 2003, provide an easier alternative to traditional 401(k) loans. The Reserve, the New York-based company that issues the ReservePlus debit card, developed it as a more efficient way for employers to “automate” 401(k) loans to their employees. “With a traditional 401(k) loan, [plan participants] have to take out one lump sum. Typically people use the entire amount, and they typically take out more than they need,” says The Reserve President Bruce Bent II. The Reserve would not release information on how many employers offer the cards in their 401(k) plans or how many people have cards now.

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