Net Gains: Why Raiding Your 401(k) Is a Bad Idea

June 3, 2008 — -- I considered it a bad idea from the beginning. Now, securities regulators agree.

I'm talking about the 401(k) debit card, which could wipe out the retirement security of countless Americans by allowing them to borrow from their retirement savings for the most trivial of expenditures.

Worried about such a scenario, the Financial Industry Regulatory Authority (FINRA) last week warned investors about the dangers of tapping your retirement savings for a night out on the town or the purchase of a new tech gadget.

"Remember that with every swipe comes the real potential to wipe out a portion of your hard-earned retirement savings," FINRA senior vice president for investor education John Gannon said.

FINRA, an industry self-regulatory organization, said the 401(k) debit card actually is a "debit and credit card rolled into one."

It acts like a debit card by allowing you to spend your own money, but unlike a normal debit card linked to a bank account, it rings up interest charges and other fees. Each transaction is a loan that must be paid back to the 401(k) account. Default on the loan and you will be hit by taxes and penalties by the IRS.

Even if paid back on time, a 401(k) loan robs the recipient of investment earnings that otherwise could compound their way to a prosperous retirement.

Earlier this year, I calculated that $3,500 borrowed from 401(k) accounts by my wife and I may have cost us about $18,000 in future retirement savings. I called it "one of the dumbest financial moves we ever made" in a February column.

Thankfully, at the time, I couldn't magnify my error by signing up for a debit card to tap my retirement savings some more.

Introduced last year by a company called Reserve Solutions, the 401(k) debit card caught public attention earlier this year and came in for harsh criticism from financial planners and other retirement-savings advocates.

The New York company pitches the 401(k) debit card as a cost-saver for employers and a boon to retirement-plan participation by eliminating "burdensome restrictions associated with taking loans" from worker accounts.