A 401(k) debit card?! It's not so bad

By Liz Pulliam Weston

I hate it when a perfectly horrible, awful, terrible idea turns out to have some merit. I get all set to rant, and then I have to acknowledge that maybe the scheme isn't so hideous after all.

Such is the case with the 401(k) debit card.

At first blush, the notion of letting workers tap their retirement funds with a plastic card seems monstrously irresponsible. Isn't it already too easy for people to squander their 401(k)s through loans, cash-outs and inadvertent withdrawals?

Well, maybe. But consider:

• The reality is that people don't want to be cut off from their money. A loan feature that gives workers the ability to borrow from their 401(k) accounts tends to increase enrollment and contribution levels.

• For most people, the ability to access their funds doesn't translate into the action of taking out a loan. Fewer than one in five workers whose plans have a loan feature actually have loans outstanding. I think that's too many -- there are darn few good reasons to get your mitts on retirement money prematurely -- but it's hardly a crisis.

Now consider the debit card program offered by Reserve Solutions. Yes, borrowers are issued debit cards to access their loan accounts. But first they have to apply for the loans and get approved by their companies' plans.

"With a traditional 401(k) loan, you apply, get approved, the money is deposited in your checking account, and you can access it with (your own) debit card," said program director David Young. "This isn't that different."

And the program, called ReservePlus, has some intriguing benefits. For example:

You get time to repay the loan if you lose your job. Once you've parted company with your company, most 401(k) plans require you to repay the balance of your loan within 90 days. If you can't, the loan becomes a permanent withdrawal that triggers taxes and penalties. Worse, you can't ever put the money back, so you've lost all those future tax-deferred returns. (Figure every $1,000 withdrawal will cost you $10,000 or more in lost retirement income.)

By contrast, ReservePlus lets you continue repaying as originally scheduled, which is typically over five years from the time you took out the loan. Instead of payroll deductions, you can pay back the loan with checks, online bill pay or automatic debits from your checking account.

You can pay more than the minimum. Most 401(k) loan programs force you to repay with fixed payroll deductions over five years. If you want to pay back the loan faster, you're usually out of luck. Unless you can pay the entire balance in one lump sum, you're stuck with five years of deductions.

With ReservePlus, you can pay more than the minimum, Young said, and many borrowers do. The average borrower in the program, he said, pays 14% more than the minimum required. On a $5,000 loan, those larger payments could get somebody out of debt eight months quicker.

Your money is still earning returns until you need it. Not stock market returns, mind you; once you're approved for a loan, the amount is transferred to a money market account or another "safe" option. But until you actually withdraw the money, it continues earning interest.

Contrast that with a traditional loan, in which your investments are sold to raise the cash you've requested and the whole amount is deposited into your checking account (or given to you in a check). Young says the typical borrower in ReservePlus ends up pulling out just 65% of the money originally requested.

It's not exactly a trend

All this convenience comes at a price. Traditional 401(k) loans have an interest rate of 1 or 2 percentage points above the prime rate. If the prime rate is 6%, you might pay 7% or 8% on your loan, but you're paying the interest back into your own account.

ReservePlus loans, by contrast, charge 2.9 points above the prime rate, or 8.9% if the prime rate is 6%. And that extra 2.9% goes into its pockets, not yours. Only the portion of your payment that equals the prime rate returns to your account.

Continued: 4 questions before you borrow

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