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401k credit cards are a unique item; they’re similar to a debit card because you’re withdrawing money from your own 401k account but they’re also closely related to credit cards because you pay fees and penalties for the usage. 401k credit cards are becoming very popular, allowing cardholders to take money out of their 401k with permission from their employer instead of applying for a loan to get access to money they need.
401k credit cards–or 401k debit cards–work by basically giving you access to a loan that you access with your credit card. Before using one of these cards you’ll need to get permission from your employer. You may get the loan approved as a revolving line of credit, or a one-time deal. If you set up your 401k loan as revolving you’ll be borrowing against the approved amount as you pay the total down. Non-revolving 401k loans, on the other hand, involve money that you can’t borrow again after you repay it. Usually, the total you are allowed to borrow from your 401k is based on two things: the amount you have vested according to the IRS and the amount you have deposited. You can only borrow 50% of your vested balance or $50,000, whichever amount is lower. Keep in mind that you may qualify for an additional $10,000 loan over your limit. It’s also important to note that your employer may actually limit what you can withdraw and how you use it.
Once your loan is approved and you’re offered this 401k credit card, the total amount of the loan is put into a money market fund. Here’s a very interesting fact to keep in mind when using a 401k credit card: all purchases and transactions made with the card are considered separate loans. Each will have its own terms of repayment.
Every month you’ll receive a bill in the mail in the same way you would a traditional credit card. Your approved loan amount is shown, along with how much you use daily and how much needs to be repaid. All payments will go to the principal balance and the interest you’ve accrued so far. You’ll pay two types of interest when using a 401k credit card. You’ll pay a variable fee that’s based on the margin of your account and you’ll pay the interest charged to your account that’s tied to the prime rate. All loan repayments have due dates and a minimum amount that needs to be paid, much like credit cards.
If you’re already set on taking money out of your 401k before you retire, 401k credit cards can be a good option. They give you fast access to your money once your loan is approved. They also allow you to earn interest on the loan amount before its withdrawn because the funds are transferred to a money market fund. Receiving your 401k loan as a check, on the other hand, means that the full amount is withdrawn immediately and earns no interest. Lastly, 401k credit cards allow you to withdraw money as you need it instead of getting approval each time you decide to withdraw.
There are, however, a number of downfalls to using a 401k credit card. To begin with, you’ll probably pay more interest this way because each transaction is treated as a separate loan. You’re also responsible for making payments on your own, whereas payments are automatically deduced through your payroll in a traditional 401k loan. Lastly, 401k credit cards have no grace period; all transactions begin to accrue interest as soon as they are made.