Would You Trust Your Clients With a 401(k) Credit Card?

What You Need to Know

A recent analysis about the potential to create 401(k) credit cards to streamline borrowing from retirement accounts has struck a nerve among advisors.
The skeptics’ concern is that the ease of use of such credit cards would inadvertently encourage excess leakage from retirement savings.
Some advisors are more open, arguing that emergencies are inevitable and that funds sometimes need to be accessed quickly and easily.

Practicing financial advisors often have strong opinions about academic research that suggests a new potential course of action — from novel investment philosophies to alternative ways of running a successful practice — but a recent analysis about the potential to create “401(k) credit cards” has clearly struck a nerve.

The idea was outlined in a new blog post published this week by the well-known researcher Alicia Munnell, director of the Center for Retirement Research at Boston College.

The basic notion is that these 401(k) credit cards would help individuals avoid having to make hardship withdrawals or rely on predatory payday loans or traditional credit cards when they don’t have sufficient liquid funds to meet an unexpected financial burden.

The cards would, in essence, present a highly streamlined pathway for individuals to draw (and repay) loans from their own 401(k) accounts, cutting out the significant administrative burden associated with traditional loans from tax-advantaged retirement plans.

Asked by ThinkAdvisor for their thoughts on the concept, a sizable number of financial advisors who focus on retirement planning shared what can only be called significant skepticism, though a smaller number agreed the concept is potentially useful if presented to savers in the right context.

The skeptics’ concern is that the ease of use of such credit cards would inadvertently encourage excess leakage from retirement savings and thereby deepen the already sizable retirement savings gap facing the American workforce.

Munnell’s post acknowledges the likelihood that advisor industry practitioners would react this way, and she encourages the skeptics to think about the potential benefits such cards would deliver for employers and employees alike. Ultimately, Munnell argues, workers need a reliable and readily accessible source of funds to confront the inevitable shorter-term emergencies that can arise during the long-term effort to prepare for retirement.

Not a Novel Concept

As Munnell explains, the 401(k) credit card concept was originally proposed in the 1990s by the late Franco Modigliani, an MIT economics professor and Nobel laureate, and Francis Vitagliano, an employee benefits practitioner. Their proposal, Munnell writes, would allow employees to quickly access a limited amount of their 401(k) money — the lesser of $10,000 or 40% of account balances.

“For 20 years, I have liked the idea of attaching a credit card to 401(k) accounts so that account holders would have an easy source for emergency saving,” Munnell writes. “My colleagues mocked me mercilessly. Now that they have moved the need for emergency saving to the top of the retirement policy agenda, some [admit] that a 401(k) credit card may not be such a bad idea after all.”

Munnell argues these cards would be helpful to employers. As she points out, the easiest way for employees to access their 401(k) balances currently is through a loan.

“But loans involve a lot of administrative hassle and are expensive for employers,” she posits. “The credit card proposal would be administered by a third party, such as Master Card, Visa or American Express, so the cost would be dramatically reduced and paid by the credit card user.”

Further, she argues, the card would also be great for employees.

“Today, credit card users who don’t pay their full balance each month face average interest charges of 20%,” Munnell points out. “Low-income households often turn to payday lenders who charge considerably more.”

With a 401(k) card, on the other hand, the borrowing cost would be set at the current prime rate, which the employees pay to themselves, plus a modest service fee.

Criticism From the Start

As Munnell recalls, Modigliani’s and Vitagliano’s proposal was criticized “by all factions at the time.”

“Critics’ main concern was that such a product would undermine retirement saving,” she says. “But capping the loan would limit the exposure, and, under current law, the loans would have to be paid back in a maximum of five years.”

A secondary concern was that adding another credit card would encourage people to borrow more than they would otherwise. However, given that people are already awash in credit cards and other means of borrowing, Munnell argues this is unlikely.

Munnell goes on to compare the simplicity of the credit card approach with the pension-linked emergency savings accounts (PLESAs) established by the Secure 2.0 legislation adopted by Congress late last year.

“The legislation gives employers the option to auto-enroll their employees, at a maximum rate of 3% of salary, into these Roth accounts,” Munnell says. “If the employer matches contributions to the already-existing account, they must match employee contributions to the PLESA. However, the match goes to the traditional account, not the PLESA.”

Once the account reaches $2,500, contributions are capped.

“To use the money, the employee must transfer the money from the PLESA to an account that allows for transactions,” Munnell says. “Somehow, I don’t think PLESAs are likely to catch on like wildfire.”

What Skeptical Advisors Have to Say

Nearly a dozen financial planners responded to a request for comment sent to members of both the Financial Planning Association and the XY Planning Network, and most of the responses were negative.

For example, Mark Struthers, the founder of a firm that focuses on supporting the planning needs of mid-career professionals called Sona Wealth, says the researchers “are not wrong that payday loans do a lot of damage, but what they miss is human nature.”

“No one is perfect,” he warns. “Most will abuse the option if we allow too-easy access to retirement funds. Not all, but most. And it’s not just a lack of discipline. They don’t understand the consequences of accessing the 401(k).

“For the employee to be in a healthy financial place, there has to be more friction between them and accessing their retirement money,” Struthers argues. “If they can treat their 401(k) like an ATM, they will give in to their worst impulses, sacrificing their retirement and financial well-being.”

Jarrod Sandra, owner and financial planner at Chisholm Wealth Management, was a little more direct in his criticism, writing that he is “100% out!”

“Credit card debt is a problem because most people just swipe and don’t think about the repercussions until later,” he warns. “So, allow people to do that with their retirement savings and we could exacerbate our whole retirement crisis even more. Besides, it doesn’t take that long to get loan proceeds, though 401(k) loans are pretty terrible all around, in my opinion.”

As Sandra emphasizes, general 401(k) loans can be used for anything, and that’s a problem.

“Boat, car, vacation, home remodel — you name it,” he writes. “Now, life happens and people fall on hard times, and it is a lifeline to get a 401(k) loan to make ends meet. That can be a great feature, and I’m glad we can have those opportunities for those in true need. Nevertheless, that’s not always the case when it comes to these loans.”

In the end, Sandra says he is “out on the credit card, but in for making participants responsible for paying their own loans versus their company administering it through their paycheck.”

The Middle Ground

Tim Melia, principal and financial planner with Embolden Financial Planning, was among those advisors who offered a more neutral take.

“If a credit card attached to a 401(k) account were to be made available, I would encourage clients to think about it in the same way as a 401(k) loan,” Melia writes. “Is the present expense worth putting at risk the future retirement savings goal? In emergency situations when all other emergency funds have been exhausted, a client may be faced with the reality that borrowing from a 401(k) is the solution.”

Melia says he would be comfortable as a financial planner if a client had a 401(k) credit card so long as they were also disciplined and responsible with the use of debt, had a sufficient emergency fund in place and were only planning to use the 401(k) credit card as a secondary emergency fund source for non-discretionary expenses.

“There are many considerations and impacts on financial plans when utilizing retirement assets for non-retirement purposes,” he warns. “It would be pretty important to discuss those with a client in tandem with the acquisition of a 401(k) credit card.”

Other advisors shared markedly harsher criticism, with more than one referring to the concept as a “terrible idea.” One wrote that “this is almost as dumb as [recordkeepers] allowing 401(k) participants to invest in cryptocurrency.”

Others argued the current loan framework is perfectly sufficient.

“The extra legwork, even if it is just filling out a traditional 401(k) loan application, may even prompt consumers to reach out to an expert for advice, which I would consider a good decision,” writes Christopher Diodato, founder and lead financial planner of WELLth Financial Planning.

Credit: Shutterstock

Practicing financial advisors often have strong opinions about academic research that suggests a new potential course of action — from novel investment philosophies to alternative ways of running a successful practice — but a recent analysis about the potential to create “401(k) credit cards” has clearly struck a nerve.

The idea was outlined in a new blog post published this week by the well-known researcher Alicia Munnell, director of the Center for Retirement Research at Boston College.

The basic notion is that these 401(k) credit cards would help individuals avoid having to make hardship withdrawals or rely on predatory payday loans or traditional credit cards when they don’t have sufficient liquid funds to meet an unexpected financial burden.

The cards would, in essence, present a highly streamlined pathway for individuals to draw (and repay) loans from their own 401(k) accounts, cutting out the significant administrative burden associated with traditional loans from tax-advantaged retirement plans.

Asked by ThinkAdvisor for their thoughts on the concept, a sizable number of financial advisors who focus on retirement planning shared what can only be called significant skepticism, though a smaller number agreed the concept is potentially useful if presented to savers in the right context.

The skeptics’ concern is that the ease of use of such credit cards would inadvertently encourage excess leakage from retirement savings and thereby deepen the already sizable retirement savings gap facing the American workforce.

Munnell’s post acknowledges the likelihood that advisor industry practitioners would react this way, and she encourages the skeptics to think about the potential benefits such cards would deliver for employers and employees alike. Ultimately, Munnell argues, workers need a reliable and readily accessible source of funds to confront the inevitable shorter-term emergencies that can arise during the long-term effort to prepare for retirement.

Not a Novel Concept

As Munnell explains, the 401(k) credit card concept was originally proposed in the 1990s by the late Franco Modigliani, an MIT economics professor and Nobel laureate, and Francis Vitagliano, an employee benefits practitioner. Their proposal, Munnell writes, would allow employees to quickly access a limited amount of their 401(k) money — the lesser of $10,000 or 40% of account balances.

“For 20 years, I have liked the idea of attaching a credit card to 401(k) accounts so that account holders would have an easy source for emergency saving,” Munnell writes. “My colleagues mocked me mercilessly. Now that they have moved the need for emergency saving to the top of the retirement policy agenda, some [admit] that a 401(k) credit card may not be such a bad idea after all.”

Munnell argues these cards would be helpful to employers. As she points out, the easiest way for employees to access their 401(k) balances currently is through a loan.

“But loans involve a lot of administrative hassle and are expensive for employers,” she posits. “The credit card proposal would be administered by a third party, such as Master Card, Visa or American Express, so the cost would be dramatically reduced and paid by the credit card user.”

Further, she argues, the card would also be great for employees.

“Today, credit card users who don’t pay their full balance each month face average interest charges of 20%,” Munnell points out. “Low-income households often turn to payday lenders who charge considerably more.”

With a 401(k) card, on the other hand, the borrowing cost would be set at the current prime rate, which the employees pay to themselves, plus a modest service fee.

Criticism From the Start

As Munnell recalls, Modigliani’s and Vitagliano’s proposal was criticized “by all factions at the time.”

“Critics’ main concern was that such a product would undermine retirement saving,” she says. “But capping the loan would limit the exposure, and, under current law, the loans would have to be paid back in a maximum of five years.”

A secondary concern was that adding another credit card would encourage people to borrow more than they would otherwise. However, given that people are already awash in credit cards and other means of borrowing, Munnell argues this is unlikely.

Munnell goes on to compare the simplicity of the credit card approach with the pension-linked emergency savings accounts (PLESAs) established by the Secure 2.0 legislation adopted by Congress late last year.

“The legislation gives employers the option to auto-enroll their employees, at a maximum rate of 3% of salary, into these Roth accounts,” Munnell says. “If the employer matches contributions to the already-existing account, they must match employee contributions to the PLESA. However, the match goes to the traditional account, not the PLESA.”