Sunday, July 20, 2008

Senators Look to Control Loans & Debit Cards on Your 401(k)

Senators Herbert Kohl, D-WI, and Charles Schumer, D-NY, on Wednesday announced legislation setting limits on the number of loans that can be taken on your 401(k) and to prohibit 401(k) debit cards.

Currently, the law states that you can borrow up to 50% of your current balance or $50,000 whichever is less. The interest rate that is charged varies by plan, but usually 10% is used. The repayment period for the loan cannot be greater than 5 years from the date of the loan. Of course, this is the law, but your 401(k) may not allow loans or have more stringent rules.

According to a report by The Center for American Progress Action Fund, in 1989, there was a total of $6 billion in 401(k) loans. In 2004 that number had ballooned to an inflation adjusted $31 billion. This is obviously a big change.

The biggest issue is that loans from 401(k)'s do not generate returns, and usually, the employee stops contributing to the plan to payoff the loan. Thus, the employee is hit with zero contributions and no returns. Not a good long term strategy.

Additionally, 401(k)'s were established to fund retirements after the demise of defined benefit plans (pensions). By lessening any amount you have for your future retirement, you are actually putting in jeopardy that long term plan.

While the legislation seems to be aimed more at receiving some press considering the law already on the books for borrowing from your 401(k), prohibiting the 401(k) debit cards that have started to appear is a great idea. Those cards should not be in place at any time. If there is a need, there are ways to get access to the money beyond swiping a 401(k) debit card. Your retirement is too important to make accessing it so casual.

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