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The Ready.Set.Retire! Blog

SEC Alert: The Pitfalls of 401k Debit Cards

Wesley Del Col, CFP

According to the U.S. Securities and Exchange Commission (SEC), 401(k) plan participants may want to exercise caution if offered a 401k debit card by their employers. 401k debit cards typically allows retirement plan participants to borrow up to $50,000 or 50% of the value of their retirement plan, whichever is less, through use of a debit card. But, a 401(k) debit card is not like a debit card that deducts money from a checking or savings account. Instead, early withdrawals from 401(k) accounts are loans that employees make to themselves out of their own retirement savings.

SEC Alert The Pitfalls of 401k Debit Cards Just as with traditional credit cards, you must repay the money you withdraw using the 401(k) debit card, along with fees and interest, or you may incur substantial penalties. The SEC recommends that plan participants consider a number of factors before using a 401(k) debit card, including possibly having to pay interest and fees on amounts they borrow from their 401(k) accounts. While noting that some of the interest paid by borrowers goes back into their 401(k) accounts, a so-called “margin” may generally be paid to the vendor of the card. A number of additional fees may also be applied, including an annual fee, a set-up fee, a cash advance fee, and fees for other services, such as express delivery.


If borrowers fail to pay the money back in the time period required by the plan, there may be significant penalties and tax consequences. Under IRS rules, 401(k) plan participants who borrow from their accounts are typically required to repay the amount of the loan in five years or less, and cannot fail to make payments for three consecutive months. Borrowers who don’t meet those conditions may owe taxes on their loan balance, and borrowers under age 59½ may also have to pay a 10% income tax penalty.


The SEC warns employees that the amounts set aside to borrow may earn a lower rate of return than the rest of their 401(k) assets. This is because funds the participant may wish to borrow are often placed in a money market fund, which usually produces lower returns than other 401(k) plan investment options, such as mutual funds or stocks.


In addition, the SEC cautions employees that, unlike 401(k) contributions, repayments of 401(k) debit card loans are not automatically deducted directly from payroll. Instead, borrowers need to take action to repay the balance.


Withdrawing money from your retirement account under any circumstances, including with a 401(k) debit card, should be carefully considered. Remember to weigh all the pros and cons, so you can make an informed decision.