401(k) Debit Cards: A Smart Idea or Borrowing Away Your Future?

Between the rising cost of living and the availability of bank loans and equity lines of credit shrinking because of the current housing market many people are looking at their 401(k) retirement accounts as a way to supplement their income. While borrowing against your retirement account has always been available to most investors, one investment firm in New York has made this option even easier by offering debit cards for your 401(k) account. These debit cards make dipping into your retirement for emergencies easier, but is it a good idea to borrow against your future?

How do 401(k) Debit Cards Work?

First your employer must sign up for the service so that it is available to eligible employees. After that you must apply for a loan against your 401(k) with your employer. The limit on how much you are allowed to borrow can be set by your employer or follow the general rule of one-half of your account or a maximum of $50,000. If your loan is approved then this becomes the limit you are allowed to withdraw using your debit card.

You can use your debit card to withdraw cash at ATMs or to make purchases, the same as a regular debit or credit card. And like a credit card you will receive a monthly statement and must make monthly payments on it. Each time you withdraw money you will have 60 months to pay off the balance. Fees and interest above the amount of interest you pay yourself back will be added to your bill.

The Cost of Borrowing against Your Future

While having your 401(k) money easily available for emergencies may sound like a good idea most experts think it's a costly mistake. Unlike a traditional loan against your 401(k) where the money is automatically deducted from your paycheck and the interest you pay is to yourself, with a debit card you make monthly payments and pay interest to the card company. The interest rate is 2.9% over the prime rate and the interest is accumulated as soon as you use the card. Also, since this is not a payroll deduction there is a greater risk you may default on the loan and have to pay additional fees. If you miss three payments you are liable for the 10% penalty fee for withdrawing the money early and you have to pay taxes on it. With costs like these you would be better off using a traditional credit card instead of borrowing against your retirement.

Another consideration is that you will be losing money that you might otherwise have saved for your retirement. Generally, if a person is looking at borrowing from their retirement account it is more than likely a last resort option. Therefore, while they are paying off the loan they will probably not be adding additional money to their 401(k) savings. Financial experts figure that for every $1,000 borrowed from 401(k) accounts the person loses $10,000 in retirement savings. That's a big chunk of money to lose when you may need it most.

Should 401(k) Debit Cards be an Option?

The costs involved and the loss in savings for Americans has prompted legislators in Congress to work on a bill banning or limiting the use of these 401(k) debit cards. They would like to stop companies from offering these debit cards or, at the very least limit the amount of times a person can draw on their account. Some senators in Congress feel that risking people's retirement savings is a bad economic strategy. 401(k) savings accounts were created to allow people to save tax-free for their retirement, not for the purpose of purchasing a new car or wide-screen television.

Proponents of 401(k) debit cards disagree. They feel that this is yet another way for cash-strapped families to make ends meet in tough economic times. Companies have also found that it is easier to talk younger workers in their 20's and 30's into starting a retirement savings account if they know they can have access to the money if necessary. It has been found that the average person who borrows from their retirement account does so after much thought, not on a whim. Having the option of a loan makes it easier for people to commit to saving if they know they can use it in an emergency.

For the most part, financial experts agree that borrowing against your future is a bad financial move. Finding alternative sources to finance purchases or to bring in extra cash makes more sense than taking money from your 401(k) savings. If your company offers 401(k) debit cards you should think very carefully before choosing to obtain one. Having one may risk your chance of enjoying retirement without financial worries.