A decade ago, when Americans took part in investor knowledge surveys, most people did not even know what stocks or bonds were, recalls Barbara Roper, director of investor protection at the Washington, D.C.-based Consumer Federation of America. But the one thing that just about everyone knew for sure, she says, was that they could borrow against their 401(k) plans.
Now, the advent of 401(k) debit cards, which allow people to withdraw from their 401(k) plans the way they would from say, a home equity line of credit, has made it all that much easier for people to access their retirement savings–something that Roper believes is dangerous for the future of retirement finance in America. “I understand that to a limited extent, assuring investors or employees that there is some way that they can access their 401(k) plans in an emergency is important,” Roper says. “Making that too easy, though, is a mistake. We should not consider our 401(k) plans as emergency funds or general purpose savings accounts to turn to any time we want money.”
When the global financial system is being pulled through the wringer and the future of the American economy looks, to say the least, bleak, experts like Tom Foster, national retirement expert for Connecticut-based insurance giant The Hartford, acknowledges that it’s fairly easy to understand the thought process behind 401(k) debit cards. This is, after all, a time when consumers are being hit hard from all sides by a host of factors including high energy prices and a mortgage crisis. Many Americans are also losing their jobs, so it’s natural that consumers would want access to as many funds as they can get and as quickly as possible, and some companies would look to offer them this option.
Yet Foster cautions that withdrawing from a 401(k) plan with a debit card is nothing but a quick-fix solution for long-term, more lasting problems. “One of the main facets of a 401(k) plan is letting the money sit and work over time,” Foster says. “When you take money out of your 401(k) plan, you have to pay it back and if you don’t pay it back, you put yourself into an adverse tax situation.”
The Securities and Exchange Commission (SEC) has also highlighted the tax complications that could arise from 401(k) debit card withdrawals. Earlier this month, the agency posted precautions on its website, noting that a repayment for a 401(k) loan made using a 401(k) debit card includes numerous fees as well as margin paid to the card vendor. Also, the SEC notes, amounts borrowed through 401(k) debit cards are set aside in a money market fund until withdrawn, and these funds may earn a lower rate of return than other investment options available in 401(k) accounts. “Unlike other 401(k) loans which are automatically repaid by payroll deductions, debit card 401(k) loans must be repaid directly by the employee,” the SEC notes. “As with all 401(k) plan loans, there will be penalties and tax consequences if the loan is not repaid within the permitted time period. Tax will accrue on unpaid loan balances, as will a 10% penalty for participants younger than age 59 1/2.”
Despite these warnings, though, it’s likely that the popularity of 401(k) debit cards will increase as a result of the ongoing credit crunch, much to the dismay of financial advisors such as Bob Mecca, CFP and founder of Prospect, Illinois-based Robert A. Mecca & Associates. “Many Americans cannot tell the difference between needs and wants and so they bury themselves in debt they cannot pay,” Mecca says. “Easy access to debt and cash appeases the appetite for today but at a cost of jeopardizing one’s future financial security.”
By definition, a 401(k) plan is a forced retirement savings account, and such accounts will be the primary resource of money during retirement, Mecca says. “Raiding your 401(k) now means less later.” Roper agrees: “It is difficult enough to save enough money to fund a comfortable retirement, and this will become impossible if workers constantly pull money out of their 401(k) plans.”
While this is certainly a time in which many people really need money to pay off their debts, it is, ironically, the worst time to be withdrawing from a 401(k), Foster says, since the market downturn has simply hammered most accounts and people actually have less to borrow from. His advice is to exhaust all other loan possibilities before turning to the 401(k) option, and then, to consult with a financial advisor on the pros and cons of borrowing from a 401(k). “Professional advice is crucial now since most participants do not have the background information needed to make a decision about 401(k) debit cards, and all that they can see is that they have easy access to their money,” Foster says.