Tapping Your 401(k) with Plastic
By Amey Stone
Tapping into your 401(k) funds could soon become as easy as slapping down some plastic at the checkout. A controversial plan to create a kind of 401(k) credit card -- you would use it like ordinary plastic, but the money would come out of your 401(k) account in the form of a loan -- is gaining some momentum.
ING U.S. Financial Services is currently considering the option. And a system for getting credit-card companies to administer and process 401(k) loans was presented at the Oct. 25 conference of the American Society of Pension Professionals & Actuaries. "A natural evolution of that thought process would be to add a credit card," says Howard Phillips, an independent consulting actuary who helped develop the new loan-administration system.
A 401(k) credit card sounds like a terrible idea, dangerous even. Transforming retirement savings into easy credit available for impulse purchases is tantamount to handing a seven-year-old a chocolate bar and telling her not to eat it until she grows up.
"If people start viewing their 401(k) plan as another checking account, that certainly isn't going to get them to their retirement goals," says Lori Lucas, director of participant research at benefits consulting firm Hewitt Associates (HEW ). She worries that businesses could be sending participants the wrong message. "If loans are that easily available, it indicates that's an appropriate way to use the money."
As crazy as it sounds, however, legitimate reasons exist for eventually adding such a service to their 401(k) plans. Advocates argue that giving people easy access to their savings will encourage more of them to save. Currently, participation rates are pitifully low. Overall, only 70% of people join the company 401(k), and of employees in their 20s, only 45% participate, Hewitt has found.
The nonprofit Employee Benefit Research Institute (EBRI) has found that employee contributions tend to be slightly higher at companies that allow loans, says EBRI President Dallas Salisbury. Other researchers contend that more individuals would participate in plans if they could tap their savings through a card.
Another reason the idea isn't as outlandish as it sounds: For consumers who need a loan, using their 401(k) as a source of funds is a better financial deal than taking on more credit-card debt. Under the administrative system introduced at the recent conference of pension actuaries, borrowers would pay the prime rate (currently 4.75%) plus about 2.5% to 3% that would go to the credit-card concern administrating the loan.
That rate of less than 8% is far better than the average 14% rate credit cards charged. Plus, 401(k) borrowers pay most of that interest back to themselves, supplementing their retirement-savings balance.
How dangerous are 401(k) loans? Not very, it turns out. Research shows that 401(k) loans are already widely available and easy to get, but they aren't overused. As much as 98% of plan sponsors offer general-purpose loans, Hewitt has found. According to EBRI, about 18% of plan participants have loans outstanding, with low-income participants more likely to indulge. Another study by EBRI found that loan balances totaled only 14% of total account balances.
The worry about issuing an actual credit card to participants is that it would entice people to borrow from the plan when they wouldn't have otherwise. More borrowing means more people who can't repay the loans. They then would suffer a 10% penalty for withdrawing those funds early, owe extra income taxes, and would see their retirement savings dwindle. That's a heavy burden for someone who's already facing financial hardship.
However, one improvement offered by having a credit-card company administer the loan, points out actuary Phillips, is that if employees borrow from the plan and then lose their job, the credit-card company could continue to administer the loan. Most plans now require a terminated employee to repay the loan immediately, or it's considered a withdrawal.
The 401(k) credit-card concept remains highly controversial and may never make it to market, even as momentum appears to be building. Banc One passed on the idea after exploring it in the mid-'90s, when similar concerns were raised.
After a recent newspaper suggested ING was about to roll out such a product, it quickly issued a tersely worded release explaining that it was just exploring the idea. "As a company, we have not reached a definitive conclusion with respect to the theory of how a credit-card like instrument may or may not enhance 401(k) participation," ING spokesperson Caroline Campbell said in the statement. "The company intends to take a measured pace and, over time, fully review the pros and cons of the existing theory and consider the appropriateness of such an instrument in the marketplace."
Yet despite the concerns, looking into the 401(k) credit-card idea has some merit. And if card companies are starting to administer 401(k) loans, then issuing the plastic may not be far behind.
Stone is a senior writer for BusinessWeek Online in New York
Edited by Beth Belton