401(k) debit cards make loans a risky business
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Some of the added interest charges could be offset. Unlike with standard, lump sum-based 401(k) loans, ReservePlus interest charges only apply to withdrawn funds while the rest of the earmarked loan funds continue to gain interest.

The cost of borrowing made easy
Weller outlined how debit card withdrawals on 401(k) funds could cost significantly more than simply taking out a standard, lump sum-based 401(k) loan.

Weller estimates that payments for five years on $5,000, under the ReservePlus terms, will cost borrowers about $425 more than a standard 401(k) loan of $5,000. But what worries Weller more than the added fee and interest costs is making it too easy for cash-strapped consumers to access 401(k) savings to pay for everyday items.

According to Weller, most 401(k) plan administrators place restrictions on 401(k) loans, such as restricting their use to medical emergencies. There are also provisions allowing early withdrawal of 401(k) funds without penalties in cases of extreme personal hardship. The ReservePlus loan program allows access to 401(k) funds for anything that can be purchased with a Visa debit card or for cash at an ATM.

"We are not crazy about 401(k) loans, but there are situations where they are unavoidable," Weller says. "The reason why people don't borrow frivolously on them (401(k) plans) now is because there are restrictions on them."

Even standard 401(k) loans diminish long-term retirement accounts by an average 13 percent, Weller says. Easier access to 401(k) funds likely would diminish those savings even more, he says.

Weller also worries that 401(k) loan default rates would rise with debit card-based 401(k) loans because consumers make monthly payments on their own to a third party instead of tying 401(k) loan payments to paycheck withholding.

A loan default means that borrowers would be hit with the full tax payments and penalties applied to an early withdrawal before the age of 59½.

Gail Hillebrand, a senior attorney for Consumers Union, says using 401(k) savings as a line of credit with an easy-access debit card attached opens the door for consumers to borrow smaller amounts more frequently from 401(k) savings. The added fees and higher interest could pile up.

"If you are borrowing small amounts, these set-up fees will make it quite expensive to borrow, and if you borrow large amounts, you may be decimating your retirement," Hillebrand says.

Allowing borrowers to tap 401(k) savings for a line of credit with a debit card also sends the wrong message to consumers about saving for retirement, Hillebrand says.

"A 401(k) loan ought to be a carefully considered, last-resort choice and putting that on a debit card is going to make it too easy to borrow against your future," she says.

Regulators also are taking a dim view of 401(k) loans with debit cards attached to them. John Gannon, senior vice president of the Office of Investor Education Financial Industry Regulatory Authority, or FINRA, testified that such loans carry new risks for borrowers, including possible tax penalties for missed payments and the potential for third-party creditors to take 401(k) funds in a personal bankruptcy. Savings in 401(k) plans generally are protected from creditors under federal bankruptcy laws.

Filling a 401(k) gap?
Access to card-based 401(k) loans is limited so far. Reserve Solutions is the only company offering these loans, according to David Wray, president of the Profit Sharing/401k Council of America -- a Chicago-based nonprofit group that closely tracks 401(k) plans offered by employers. Wray says it is his understanding that only two employers are offering the ReservePlus product to employees.

Reserve Solutions declined an interview. But Bruce R. Bent, chairman of Reserve Solutions, told the Special Committee on Aging that the ReservePlus debit card-based 401(k) loans give consumers more control and flexibility than traditional 401(k) loan options while still maintaining the benefits of a 401(k) savings plan.

"With ReservePlus, the participant's funds remain in the plan, continuing to earn sheltered investment returns until the participant withdraws them," Bent said in his testimony. Plan administrators still must approve any loans under IRS rules with the ReservePlus product, he said.

Bent testified that debit card-based 401(k) loan amounts are on average about 30 percent less than standard 401(k) loan amounts. The average 401(k) loan amount in 2007 was $8,100, according to Hewitt Associates, a Chicago-based human resources consulting firm.