401K Credit Cards

Everyone understands how a traditional debit card, works: you withdraw money and make charges against the money you actually have in your bank account. Do you know about 401K debit cards?

These cards allow accountholders to withdraw money from your own 401K account, with permission from your employer, instead of the typical “loan” some people would get from their 401K plans.

A 401K debit card is actually more closely related to a credit card than a debit card, because you end up paying for a large number of fees and penalities for the priviledge of using a debit card linked to your 401K account.

How do 401K debit cards work?

Because they are essentially a loan that you access with the debit card, you must first get employer approval for the 401K loan. In some cases, the employer will approve the loan one time, or as a revolving line of credit. If you set up the loan as revolving, that means you can borrow against the approved amount as you pay it down – while a non-revolving 401K loan is money you cannot borrow again after repaying it. The amount of money you can borrow from a 401K loan is based on how much you've deposited into the account, and your vested balance according to IRS rules. You are limited to borrowing 50% of your vested account balance, or $50,000 whichever is less. At times, an exception can be made for a $10,000 loan out of your 401K account, even if that exceeds your 50% limit. Your employer is actually able to limit the amount you're allowed to borrow and for what purpose you use the borrowed funds for.

If the employer approves your request for a loan and offers a debit card to access it, the approved amount is then transferred into a money market fund and the debit card is given to you for your use. There are some plans that also allow you to write checks from your borrowed funds. If you use the card or checks multiple times, each day's transactions are considered separate loans and each are subject to individual terms of repayment.

How 401K Loans are Paid Back

Each month, you'll receive a bill – just like you do your credi tcards – that shows you the total amount of your approved loan, how much you've used on a daily basis, and how much of it you need to repay. Because the 401K loan is in fact a loan, even though it's being accessed with a debit card or check, you will make payments that go to the principal balance borrowed and the interest youv'e accrued. There are two types of interest rates you pay for 401K loan debit card use – a variable fee which is based on the margin, which is calculated based on the amount you withdraw each month, and paid to the vendor providing your debit card, and the interest charged to your debit card use which is tied to the prime rate. Also, like credit cards, your loan repayments have a due date and a minimum amount which most be paid.

Are 401K Debit Cards a Good Idea?

There are a few advantages to using the debit cards with a 401K loan, if you disregard the disadvantages associated with taking money out of your 401K before retirement to begin with.

Advantages of using the debit card to access the loan over other alternatives include:

• faster access to the funds once approved
• the money from your loan is deposited into another money market account when you are going to access them through a debit card, so they will continue to earn interest until you actually withdraw or use them with the debit card. When you get a 401K loan as a check, they withdraw the full amount of the loan and send to you, meaning you have that much less earning interest for you immediately.
• Once approved for the loan amount, you can withdraw money as needed from that account rather than getting approval each time.
• Disadvantages of 401K debit cards
• In addition to the major disadvantage of withdrawing money in ANY format from your retirement fund before you retire, there are a few other disadvantages to withdrawing the money using a debit card, including:
• Potential to pay more interest than a traditional 401K loan, since each debit card transaction from one day to the next will be treated as a separate loan.
• Most 401K loans are repaid automatically through payroll deductions, but with debit card 401k loans, you have to make payments on your own, the same way you would a credit card payment. If you miss three payments in a row, your loan will be considered a default, the full amount borrowed becomes taxable and you'll get hit with a 10% early distribution penalty by the IRS if you're younger than 59 and a half years old when you default.
• Unlike credit cards that offer a grace period on purchases where no interest accrues, money used through a debit card on your 401K account is charged interest as soon as it is withdrawn.

by: Debbie Dragon