Debit card allows investors to tap 401(k)s

A deteriorating economy and skyrocketing prices for necessities such as gas and heating fuel are driving consumers to find new sources of cash, and many are taking out loans from their retirement plans to make ends meet.

About 21% of 1.9 million participants had a loan outstanding on their retirement account for 2007, according to a survey of clients of Hewitt Associates LLC, a Lincolnshire, Ill-based human resources firm. That was up from

The number of people taking out loans from their employer-sponsored retirement plans doubled to 18%, last year, from 9% in 2005, according to a survey of 2,011 workers conducted by the Transamerica Center for Retirement Studies last fall. Nearly half (49%) of those people said they were taking the loan to pay off debt.

Sensing an opportunity, Reserve Solutions Inc., a subsidiary of The Reserve, a New York-based fund company, began offering a debit card last year that allows investors to tap their 401(k) plans for loans.

The ReservePlus card is a Visa debit card that allows participants to make one application and secure multiple loans. The typical interest rate is the prime rate plus 2.9%, according to the firm.

The program is drawing criticism from service providers and financial advisers who think it will exacerbate a growing problem.

Participants shouldn’t be allowed to borrow money from 401(k)s willy-nilly, said Mike Scarborough, president of Scarborough Capital Management Inc. of Annapolis, Md., which has $1.7 billion in assets under management.

“It’s not a savings plan; it’s a long-term retirement account. I cannot see people taking money out for anything less than a hardship withdrawal,” he said.

“They shouldn’t use these things as a slush fund or mad money ac-count,” Mr., Scarborough said. “The debit card is just crazy; we already have a savings problem in this country.”

Neither the Reserve Fund nor David Young, director of ReservePlus, were available for comment.

ECONOMIC PRESSURE

The debit card is a sign of the times.

“People are struggling now, and the country hasn’t seen a serious recession since 1980,” said Alicia Munnell, director of the Boston College Center for Retirement Research in Newton, Mass.

“With rising prices it’s tough,” she said. “The withdrawals and loans are a sign of how pressed people feel.”

The Merrill Lynch Retirement Group of Pennington, N.J., is also studying the trend. Its proprietary business alone has 1,500 clients representing 2.6 million participants and $103 billion in assets.

The firm, a subsidiary of New York-based Merrill Lynch & Co. Inc., found that between the first and fourth quarters of 2007, the number of general-purpose loans from 401(k)s increased 14%, residential loans decreased 40% and hardship withdrawals increased 42%.

“We do a lot of education on our website and in statements,” said Kevin Crain, managing director, business retirement and corporate market integrated benefits, at Merrill Lynch. “They have the right to take out loans, but we want them to think about some of the issues.”

At Great-West Life and Annuity Insurance Co., between January 2007 and 2008, the number of hardship withdrawals from employer-sponsored defined contribution plans rose 56% to 709 in January 2008, from 454 in January 2007, with 42% of the 2008 loans related to eviction or foreclosure, said Charles Nelson, senior vice president at the Englewood, Colo.-based company. Residential loans fell 74% January over January, while general-purpose loans increased 13% for all of last year 2006.

The unit of Great-West Life Assurance Co. manages 20,000 different plans with 3.5 million participants and has $135 billion in assets.

Big impact

The impact of taking out a loan can be huge for the participant.

“If you take out a loan and repay it over five years, the plan suspends your contribution for five years,” Ms. Munnell said. “You’ll end up with 82% of what you would have if you left the money there.”

If the participant defaults on the loan and suspends contribution for two years, they will get 84% of what they would have received at retirement, she said.

Most advisers tell clients not to touch their retirement money.

“Unless it’s a crucial situation, it loses the purpose of having deferred returns over time for retirement,” said Robert Wasilewski, financial adviser and portfolio manager with Baltimore-Washington Financial Advisors. The Columbia, Md., firm has $200 million in assets under management.

A home-equity line of credit is one strategy that could be used instead, said Drew Tignanelli, principal and president of The Financial Consulate, a Lutherville, Md., firm that doesn’t disclose its assets under management.

“I strongly encourage clients to get to the bank and get the largest home-equity line of credit approved that they can,” he said.

“Once you get approved for it, it’s there and it’s in place,” Mr. Tignanelli said. “The worst time to ask the bank for a loan is when you need it.”

A job loss can put a person in a lower tax bracket. He or she may withdraw their money from their retirement account and put it into a Roth IRA, taking advantage of lower taxes, Mr. Tignanelli said.

And if bankruptcy appears inevitable, he advises clients to leave the money in the 401(k), he said.

“The 401(k) is protected under the bankruptcy law” Mr. Tignanelli said.

Although he doesn’t think people should take out loans from their 401(k)s, it could be acceptable as a short-term solution, said David Greene, vice president CJM Wealth Advisors of Fairfax, Va., which has $400 million in assets under management.

“It’s better than jumping on a credit card for 18 months,” he said.

E-mail Sue Asci at [email protected].

“With rising prices it’s tough.”

Alicia Munnell

Director

Boston College Center for Retirement Research