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State Benefits on Prepaid Cards: Why Consumers Lose Out

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At NerdWallet, we know a thing or two about prepaid debit cards. We’ve never really liked them, but we could rest easy at night knowing they were just one of many payment choices. Looks like we’re in for a ton of tossing and turning this week, because it turns out they’re not always a choice. If you’re receiving state benefits, like unemployment compensation or Social Security Disability, it’s probably being loaded onto a state-issued prepaid debit card.

On November 8th, California’s Employment Development Department (EDD) announced their completed transition from paper checks to prepaid debit cards, joining 40 other states in the union. States are welcoming the change at a rapid rate, since the cards are more economical than paper checks, and because some banks offer revenue-sharing agreements with the state governments. Banks, of course, benefit from interchange fees and the fees that they levy on the cardholders. But what’s in it for the benefit recipients? We did some digging and discovered that more often than not, they’re the ones who are losing out.

Why Prepaid Debit Cards?

States love prepaid debit cards for their cost efficiency. Once they issue a card, they can reload it electronically, which cuts down on printing and mailing costs. There are also lower administrative costs, since the prepaid card issuer handles all of that. Moreover, electronic payments are often more secure. Unlike paper checks, electronic transfers are harder to steal, and won’t get lost in the mail.

But it’s not just about saving money. State departments actually earn extra money from prepaid cards. They enter into an exclusive contract with a bank to issue the cards, and both state and bank get a cut. California’s cash-strapped EDD has already earned $7.7 million from their new Bank of America deal so far, and they only began issuing their prepaid cards in July of 2011. For a broke state, that kind of cash flow sounds promising. These contracts are also an excellent way for banks to pad their profit margins. Bank of America’s new partnership with the California EDD brings them approximately 2 million new (and profitable) customers automatically – just what they need after all that bad press from their debit card fee proposal.

Great for banks, bad for benefits

Prepaid debit cards might represent lower costs for cash-strapped states, and higher revenue for the card-issuing banks, but they aren’t so great for the people who receive government benefits. These cards come with a ton of hidden fees. If you’re already dependent on government benefits, you probably don’t have much money, so every little fee hurts.

We’re not just talking about ATM fees and monthly maintenance fees either, depending on which state issues the card. Some states are charging transaction and overdraft fees as well. Colorado’s prepaid debit cards actually charge the cardholder 10 cents per transaction, so it’s not just the merchant who has to pay for the privilege of card acceptance. Arkansas charges $20 overdraft fees on its prepaid cards. Oklahoma’s card charges customers 50 cents to check their balance at an ATM. And the list goes on.

Fees? What fees?

The National Consumer Law Center (NCLC) compiled a comprehensive, national list of fees like this in their Unemployment Compensation Prepaid Card Report, which takes a look at the rising use of debit card fees for unemployment benefits. One thing they discovered is that the fees vary greatly from state to state, even if the cards are issued by the same bank. For example, California and New Jersey both issue Bank of America prepaid cards and waive some of the fees for out-of-network ATM use. South Carolina uses a Bank of America card as well, but they don’t cover any out-of-network withdrawals. If you need cash and aren’t fortunate enough to live near a Bank of America ATM, you’re out of luck.

It would be nice to at least have a heads up with all these fees, wouldn’t it? It also turns out that the ease of obtaining fee information varies a lot from state to state. While some states have websites that list fees, The NCLC found that in many circumstances it’s very difficult to obtain card terms and conditions if you don’t already have one. That means you just have to deal with them when you get the card.

The upsides are limited

There are some upsides to getting a prepaid card in the mail instead of a check. If you don’t have a bank account, it’s often cheaper to use a prepaid debit card than to pay a check casher. Prepaid cards give you the ability to make purchases electronically. And, if you need to, you can get that money transferred to a regular bank account. It’s just a little less convenient. Many states allow benefit recipients to sign up for direct deposit, but this only works if you have a bank account. And, as of May 2011, six states (including California) don’t offer direct deposit at all. You can transfer the funds for free to a bank account, but you’ll have to be prepared to wait. California cardholders have to wait at least 24 hours, and often longer, for their funds to be transferred to a checking account.

What’s to be done?

For starters, we’d like to see stricter laws for prepaid debit cards. Currently, there are a few regulations in place that protect prepaid debit card users who receive unemployment benefits, unlike regular prepaid debit card users. Benefit payment cards are covered under the Electronic Funds Transfer Act, so they’re protected against loss, theft, unauthorized charges and billing errors. Customers also have to have access to periodic account statements, but issuing agencies do not have to provide them as long as customers have access to it some other way, via telephone or ATM for example.

Here’s the best thing that could happen: give benefit recipients a choice. We completely understand that prepaid cards have their upsides for some people, and for our broke state institutions. However, we think it would be helpful if they were opt-in rather than opt-out; the power of the default option has been well documented. Only one state currently lets its recipients opt out easily. Florida issues a prepaid card from Wells Fargo, but allows people the option of choosing a paper check instead. We applaud them for it, and hope others will follow suit, even if it costs states a little bit more in the long run.