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About a 401K Debit Card
How does a 401K debit card work? |
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 Perhaps having never heard "401K" and "debit card" mentioned in the same sentence before is because the very idea of allowing debit card access to a retirement plan's assets runs in the face of any conventional financial wisdom. A 401K debit card is a device that allows a participant in a 401K retirement plan to borrow from the plan conveniently and without the normal paperwork associated with such a move. To understand the process, you would make a one-time designation of a portion of the 401K plan balance -- up to $50,000 or 50% of the retirement plan balance, whichever is less -- and move it into a money market fund, where it will remain until you use the debit card to advance funds from the account.
Once the initial set-aside is completed and the card issued, accessing the earmarked funds is as simple as any other debit card transaction. Lest you think that it's a terrific idea to be able to get at those retirement funds if you need them, there are a few significant negatives to consider.
Accessing your retirement funds with a 401K debit card may be as simple as any other debit card transaction, but these are your hard-earned retirement dollars, and traditional wisdom suggests that you not take money from the retirement account early unless you have a significant financial emergency. You can't simply withdraw the funds and figure it's your money anyhow, so you'll just tighten up your retirement budget when the time comes. Remember, this is a loan from your retirement plan, and whether you like it or not, if you don't pay it back as required by your plan (generally, within five years), you'll have to pay taxes on the money you borrowed (it wasn't taxed on the way into the plan) and some really significant penalties.
Your plan will probably charge interest on the amounts you've borrowed, and may impose fees simply for administering the card. You probably won't be able to repay your borrowings using payroll deduction. Instead, you'll get a monthly bill, just like a credit card account, and you'll need to pay it from after-tax funds.
The amount of money you earmark for borrowing will sit in a lower-yield money market fund even if you don't actually borrow it. That means the overall investment yield of your 401K balance will suffer. You may need to pinch pennies a little more in retirement even if you pay back every cent you borrow and eventually close out the borrowing line to move funds back into higher yield investments.
Published on BankingQuestions.com 9/05/08
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