As the economic downturn continues, clients who find that they are retirement-plan rich but cash poor will tend to make more frequent use of 401(k) debit cards to pay for bills they can’t quite manage with their regular income. But as with all credit options, clients who misuse these cards may be getting themselves into trouble.

According to the Securities and Exchange Commission, 401(k) debit cards allow consumers to conveniently borrow up to $50,000 (or 50 percent) of the value of their retirement plan. But many consumers may forget that, like a traditional credit card balance, 401(k) loans must be paid back … with interest.

If your clients are determined to use a debit card to borrow against their retirement plans, here are some facts they should know regarding this type of loan:401(k) debit cards do not provide free money. The client will have to pay interest and may incur fees.Loan repayment is on a prescribed schedule (in five years or less and without missing three consecutive payments).

If the client falls behind, he or she must pay taxes on the entire loan balance plus a 10 percent penalty if they are younger than 59 1/2.The amount borrowed will earn a lower rate of return than the unborrowed portion of their plan.
Clients must make loan payments directly to the plan provider. They will not have the convenience of relying on their employer’s payroll deduction mechanism. If your clients are careful with these cards, they can be a helpful source of emergency cash, but as with all forms of credit self-discipline is key.

What “red flags” are affecting your business? Send your comments to the National Ethics Bureau at redflags@ethicscheck.com.