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."
