The Securities and Exchange Commission has issued a warning about the use of 401(k) debit cards that allow employees at some companies to borrow money from their retirement plans.
A 401(k) debit card lets people borrow up to $50,000, or 50 percent of the value of their retirement plan, whichever is less. However, unlike a debit card that deducts money from a bank account, a 401(k) withdrawal is a loan. Users must repay the loan, along with fees and interest, or incur substantial penalties.
In addition, while some of the interest paid will go back into the 401(k) account, a certain amount is paid to the vendor of the card. Other fees may also apply, such as an annual fee, a set-up fee, a cash advance fee, and fees for other services such as express delivery.
If users do not pay the money back within the required time period, they may face penalties and tax consequences. They are responsible for repaying the loan themselves, unlike 401(k) contributions that are automatically deducted from their paycheck.
"Under IRS rules, you typically must repay the amount you borrow in five years or less, and may not fail to make payments for three consecutive months," said the SEC. "If you do not meet those conditions, you must pay taxes on your loan balance. In addition, if you are younger than 59-and-a-half years old, you will have to pay a 10 percent penalty."
The amount set aside to borrow is put in a money market fund until the user withdraws it. Such an account may earn a lower rate of interest than other investment options from the 401(k) provider, the SEC noted.
