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How Spending ‘Spikes,’ Credit Card Debt and Plan Loans Impact Retirement Readiness

Industry Trends and Research

New research by the Employee Benefit Research Institute (EBRI), conducted in partnership with J.P. Morgan Asset Management, reveals that households with spending “spikes” are more likely to increase their credit card debt or take a 401(k)-plan loan.

Image: kitzcorner / Shutterstock.comLeveraging data across 29 million Chase households and 11 million 401(k) plan participant records to link 401(k) plan data with consumer banking data, the researchers identified 35,000 households that had three contiguous years of both 401(k) and spending data from 2016-2020 to examine how 401(k) participants behave when faced with irregular expenses.

In the resulting report—How Financial Factors Outside of a 401(k) Plan Can Impact Retirement Readiness—the researchers reveal that 9 in 10 households encountered at least one spending spike that could not be covered by their current income. In addition, more than one in three households could not cover their increased spending with their current income and cash reserves.

“As expected, this research found that the lack of income and cash reserves to support spending spikes is likely to result in higher credit card debt,” says Craig Copeland, Ph.D., director of Wealth Benefits Research at EBRI. “What’s interesting is how having household credit card debit impacts the household’s retirement security, since higher credit card utilization is correlated with lower 401(k) plan contributions and account balances.”

To that end, a household’s credit card utilization ratio plays an important role in determining whether a participant takes a plan loan, the study notes. When less credit is available via a credit card, participants seemingly have no choice but to take a plan loan to meet expenses that cannot be covered by income and cash reserves. Notably, the median credit card utilization ratio of participants taking a plan loan was 64% compared with 17% for those who did not take a plan loan.

Impact on Retirement Outcomes

Not surprisingly, higher credit card utilization is associated with lower savings rates and balances in 401(k) plans, even when controlling for tenure and income. For example, for participants with tenures of more than 15 years and incomes between $75,000 and $100,000, the median 401(k) account balance is $184,000 for those with credit card ratios of 0%. For those with credit card ratios of 80%-100%, the median account balance is $80,000. In other words, the 401(k) account balances of participants with more prudent credit card utilization were more than two times larger than those of their debt-burdened counterparts, the study notes.  

Consequently, the availability of emergency savings to cover spending spikes is a “critical factor” in preventing or stalling a cycle of increasing debt that can significantly impact retirement readiness, Copeland further emphasizes.

To that end, J.P. Morgan Asset Management retirement strategists Michael Conrath and Sharon Carson point out that SECURE 2.0 allows plan sponsors to offer an emergency savings account inside a 401(k) plan, with a maximum account balance of $2,500 for non-highly compensated employees. “Our research suggests that a maximum balance of $2,500 may be too low. But clearly, offering an in-plan emergency savings account, especially if it is paired with automatic enrollment, will encourage more employees to have at least some money set aside for unanticipated expenses,” the pair note.

Younger Workers and Plan Loans

Meanwhile, a separate report released by EBRI and the Investment Company Institute (ICI) shows that younger workers are more likely to take a plan loan as they age and accumulate larger account balances.

This report—How 401(k) Plan Participants Use Loans Over Time: An Analysis of Loan Activity of Consistent 401(k) Plan Participants, 2016–2020—analyzed 401(k) plan loan usage for a sample of 2.2 million consistent loan-eligible 401(k) plan participants who maintained accounts in each year between 2016 and 2020.

Over the five years analyzed, the increase in loan usage was largest for younger participants or those with lower job tenure as they aged into longer tenure and higher account balances available for loans. The study notes, for example, that among participants in their 20s at year-end 2016, 7% had outstanding loans at year-end 2016. However, when the five years analyzed are considered altogether, 21% of participants in their 20s had taken out plan loans.

While the likelihood of having a plan loan in any given year is relatively low, more participants had loans at some point between year-end 2016 and year-end 2020, the study further observes. Overall, roughly 3 in 10 (29%) 401(k) participants in the sample had an outstanding loan at some point in the five years analyzed, compared with 18% at year-end 2016. In addition, repeat-loan 401(k) plan participants represented 16% of the overall sample (55% of the 29% with any loans over the five years).

The study further notes that new loans tended to be modest, relative to account balances and decreased over time. For instance, the median new loan balance at year-end 2017 for participants with loans who did not have a loan balance at year-end 2016 was 16% of the total account balance. By 2020, the average loan balance for those participants had fallen to 4% of the total account balance.

“Taking a closer look at new loan activity reveals that some 401(k) plan participants appear to be using 401(k) plan loans to meet modest short-term financing needs,” notes Sarah Holden, Ph.D., senior director of Retirement and Investor Research at ICI. “Indeed, 401(k) plan participants who were observed initiating multiple loans between year-end 2017 and year-end 2020 tended to take smaller loans.”

In fact, among participants with new loans at year-end 2017 who were observed taking an additional loan between year-end 2018 and year-end 2020, about three-fifths had an initial loan of $2,500 or less.