SEC Alert: The Pitfalls of 401(k) Debit Cards

The U.S. Securities and Exchange Commission (SEC) has issued an investor alert warning 401(k) plan participants to exercise caution when offered a “401(k) debit card” by their employers.

A 401(k) debit card typically allows 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, the SEC warned, 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. 

“More akin to a traditional credit card, you must repay the money you withdraw using the card, along with fees and interest—or you may incur substantial penalties,” the alert said.
The SEC advised plan participants to consider a number of factors before using a 401(k) debit card, including the fact they will have to pay fees and will incur interest on amounts they borrow from their 401(k) accounts. While noting that some of the interest borrowers pay will go back into their 401(k) accounts, the alert pointed out that a so-called “margin” is generally paid to the vendor of the card. The SEC also warned that a number of additional fees may be applied to users of 401(k) debit cards, including an annual fee, a set-up fee, a cash advance fee, and fees for other services, such as express delivery.   

Moreover, the alert cautioned, 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 they must make payments for three consecutive months. Borrowers who do not meet those conditions will owe taxes on their loan balance, and borrowers under age 59˝ will also have to pay a 10% tax penalty.

The alert further advised 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 typically produces lower returns than other 401(k) plan investment options, such as mutual funds or stocks.

Finally, the SEC warned employees that, unlike the contributions they make to their 401(k) accounts, repayments of 401(k) debit card loans are not automatically deducted directly from payroll. Instead, borrowers must take action to repay the balance.

“In short,” the alert concluded, “you should think carefully before taking money out of your retirement account under any circumstances, including with a 401(k) debit card, and weigh the above considerations carefully.”


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