Avoiding Bad Financial Products

As a professional financial planner, I often come across finanical products that are such bad ideas that I don’t even know how (or why?) someone got them to market. Usually the answer is flat out greed. A company willing to make a buck at the expense of its customers is always out there.

A posting over at Wise Bread talks about some of these bad ideas. The one at the top of the list is the new 401(k) credit card / debit card. No doubt, this idea orgininated with the goal of allowing retirees to access their 401(k)s in an easier manner so that they could consider leaving the balance in the 401(k) plan instead of rolling it out into an IRA. (Rolling it out is almost always better – keep an eye out for the coming article on Finance Gourmet.) Now, however, some companies are offering these cards to everyone!

Virtually every withdrawal from your 401(k) that takes place before you turn 59 1/2 is subject to not only ordinary income taxes, but also a 10% penalty. So, unlike your regular ATM or credit cards, using this card will increase your taxes! How many 25 year olds do you think fully consider and understand that when they grab their 401(k) Visa to charge a pizza?

The math is a nightmare. You take your 401(k) Visa or Mastercard and go out on Friday. You drop $40 on dinner, $20 on parking, and another $40 on your night time fun for a total of $100. But, now you owe taxes on that $100 let’s call it 20% (it depends on your tax bracket of course) for another $20, PLUS the 10% penalty $10. So, that $100 night out actually cost you $130. It’s like the sale from hell. Come buy a new jacket and pay 30% more than the marked price.

For the ultimate insult, get ready to pay taxes on the fee the ATM charges to withdraw your money. Take out $100? Great, that will be $2. Don’t forget your $30 in taxes, oh and also another $0.60 for taxes on the $2 fee. A withdrawl is a withdrawl. It doesn’t matter who got the money.

The rest of the post is solid information too. Read our Credit Score article for info on why those store cards might ding your credit score. Payment protection insurance is a huge scam that I forgot all about. I’ll add that to the “To-Do” articles. Payday loans are such a bad deal that some states are looking at passing laws to curb abuses.