WSJ on 401(k) Debit Cards

So as not to be left behind in the debate over 401(k) debit card loans after the New York Times report I wrote about last week, the Wall Street Journal's Jonathan Burton reports [subscription required]: "Critics Detail the Ills Of 401(k) Debit Cards." In this report, Mr. Burton quotes several adverse reactions from the who's who in the retirement and financial planning world. Some choice comments:

"We absolutely hate it," said Jean Setzfand, director of financial security at AARP, the organization for people 50 and older. "A 401(k) loan is a last resort."

"A horrible idea," said Linda Lubitz Boone, president of investment advisory firm Lubitz Financial Group in Miami. "It's hard enough to save to begin with."

Even official watchdogs are on alert. The Financial Industry Regulatory Authority issued a stern warning about 401(k) debit cards, calling them "a tempting convenience that can have significant repercussions" on your retirement security.

The cards also have become Public Enemy No. 1 for some Washington lawmakers; Sens. Charles Schumer (D., N.Y.) and Herb Kohl (D., Wis.) blasted them this month as an apparent abuse of 401(k) plans and proposed legislation to outlaw them.

The heightened controversy about 401(k) debit cards comes with the times. There is an increasing concern that with things so tough, people living paycheck to paycheck will increasingly turn to retirement savings as a source of cash. Mortgaging your future, unless it is for an emergency or to enhance your education or career, is almost always a poor decision. You will have less money to support yourself after you retire or you will have to work more years before calling it quits.

The report does list some advantages of such loans over regular 401(k) loans:

For starters, the ReservePlus card is flexible; it can be used multiple times, for any purpose. As with a typical loan, employers set a borrowing limit based on how much you have saved for retirement. By law, the upper limit is generally $50,000 or 50% of your account balance, whichever is less. The approved amount is set aside in a money-market fund and earns tax-deferred interest until you use the card.

With every transaction, you have five years to pay back the money, and the interest rate -- now about 8% -- may be better than certain people can get elsewhere.
One advantage of a debit card is that if you are laid off or leave the company, there may be no pressure to reconcile the debt immediately. With a typical 401(k) loan, the outstanding amount must be repaid in full, usually within 90 days. Otherwise the loan amount is considered a taxable distribution.

I am sure of one thing: we have not heard the last word on this controversy yet.

Where to Spend a 401(k) Debit Card Loan? Choices... Choices...

The New York Times (Ron Lieber) is reporting on the use of 401(k) Debit Cards, and efforts underway by Senators Chuck Schumer (D-NY), and Herb Kohl (D-WI) to ban their use. The one company that offers this feature is called Reserve Solutions. If such debit card loans were to be outlawed or curbed, I will speculate that the one trick pony business model of Reserve Solutions could cause it to fail as a company.

Ron Lieber at NYT interviewed both Senator Schumer and the founder and chairman of the parent company of Reserve Solutions, Bruce Bent. It makes for a very interesting reading - I highly recommend reading the whole thing. Some excerpts:

Q. How did you first get interested in creating legislation around debit card access to 401(k) loans?
SCHUMER Over 10 years ago, I read in the paper that Bank One was offering access via a card to 401(k) loans, and I thought, this is outrageous. America has to save. If people need to access their 401(k)s because of unusual circumstances, that’s one thing. But to encourage people to take money out with a card is encouraging all the wrong values. So I said then that I was going to put forth legislation, and the bank dropped it and I thought it was over.

...

Q. Is this really that much different than simply going online and moving loan money from Fidelity or another 401(k) account administrator to your bank account?
SCHUMER It is totally different. A debit card allows people to spend on impulse. Not having one attached to a loan is sort of like having a waiting period for a gun.

Q. Are there particular types of workers to whom the debit card is especially appealing?
BENT It’s bringing in lower income and younger workers. They don’t come into the 401(k) plan in the first place because they’re unhappy with the concept of losing access to their money. Or invariably, the plans and the loans don’t work for them because they’re transient, working for one construction company at one time and another during another season.

Q. One plus of a debit card is that the issuer can see how people are actually using their money. So are they spending it on frivolous things?
BENT I can’t say. It’s proprietary, and it’s also personal information.

Q. Could an employer see that information?
BENT Well, if you outlaw the debit card, Big Brother’s ability to control expenditures is limited. They can’t control it then. With a debit card in place, Congress could dictate to us that Vendor 23, Victoria’s Secret, or Vendor 85, Joe’s Massage Parlor, don’t qualify. Or they could restrict entire categories of vendors where people could spend the money.