March 25, 2008
To improve retirement savings, we should be making it harder for workers to get their hands on 401(k) money -- not easier.
Certainly not as easy as going to the ATM machine.
But that's exactly what the 401(k) debit card by Reserve Solutions does.
The ReservePlus card allows you -- with the 401(k) plan's approval, of course -- to tap retirement money by using the card at an ATM or to make purchases at merchants that accept Visa cards.
This seems like a new way to sacrifice your future. A 401(k) is not just another savings account to use for shopping, vacations or other wants. Outside of Social Security, this is what many of us will be living on in our old age. Borrowing this money today -- and paying to do so -- means you will have less money in retirement.
"This is an amazingly dumb idea. It shouldn't have a slow death; it should be a fast one," says Michael Scarborough, president of Scarborough Capital Management in Annapolis, which manages 401(k) accounts for workers.
This is not the first attempt to combine plastic with a 401(k). Banc One Corp. in the mid-1990s proposed a 401(k) credit card. The outcry was immediate. Congress didn't like it. And Banc One backed off.
The ReservePlus card has been out since 2003, but it has only recently appeared on the radar screen of financial experts who, like Scarborough, tend to pan it.
Reserve Solutions is no longer commenting on its product. The company was founded by the Reserve, an asset manager that says it created the first money market fund in 1970.
When Reserve Solutions was still granting interviews, director David Young told Advertising Age in an article this month: "All ReservePlus is doing is making the process to acquire [money] more convenient for both plan sponsor and participant." About 5,000 to 10,000 workers have signed up, he said. That's small given the tens of millions of workers enrolled in 401(k)s.
Additionally, the company's Web site states, "Unlike traditional loan programs that immediately remove the entire line requested by you from your retirement investment account, ReservePlus keeps your money working for you within your retirement plan until the moment you access your loan line by debit card or check."
The debit card has failed to gain any traction among industry players, says Rick Meigs, president of 401khelpcenter.com. "If it started to gain some traction, you would find a lot of people shouting it down, too," he says.
It feels too much like "easy money," Meigs adds. "That bothers me."
Workers can access 401(k) money through loans or hardship withdrawals and 22 percent of participants have outstanding loans, adds Pamela Hess, director of retirement research for Hewitt Associates.
"That's very significant," she says. Employers and plan administrators, like Hewitt, aren't keen on making it even easier to tap a 401(k). "Adding a debit-card feature will ... detract from their retirement savings," Hess says.
The ReservePlus debit card follows the same rules as regular 401(k) loans.
With the card, though, money is moved out of investments and into a dividend-paying account within the plan. You may have to pay an annual fee and a set-up fee, depending on your plan -- in addition to interest on the loan. The rate will be the prime rate plus 2.9 percent. The prime rate interest is paid to your 401(k) account, but the 2.9 percent goes into the pockets of Reserve Solutions. So, you're paying nearly 3 percent to borrow your own money.
You trigger a loan when you use the card and will receive monthly statements that show the minimum payment due. Defaults occur if you miss payments for three months, which can then trigger taxes and a penalty, according to the company's Web site.
Granted, the ReservePlus card has a nice feature. Borrowers who leave their jobs don't have to quickly repay their debit withdrawals as they would do with a regular 401(k) loan. ReservePlus gives you up to five years from the day you took out the money to repay it, even if you switch jobs. That can save you from getting hit by taxes and an early-withdrawal penalty if you don't have the cash on hand.
"Just think about how many people have lost those dollars because they can't pay [the loan] back," Meigs says.
Employers typically allow loans, figuring workers would not contribute to the plan if their money was locked up for decades. But borrowing from a 401(k), whether through a loan or debit card, has some less visible costs.
By borrowing, you pull money out of investments and lose the opportunity to reap potentially bigger gains in the market than on the interest you earn on the loan. And there's the risk that borrowers will reduce their contributions -- or be prevented by the plan from contributing -- while a loan is being repaid.
Borrowing from a 401(k) should always be a last resort. Should you ever be tempted to tap your account with a debit card, do yourself a favor and pass.
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