Summary
Workers’ finances can face many challenges over their careers, potentially leading them to have to take on debt or find other sources of financing to cover the various financial challenges. This study builds on prior work done by the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management focused on defined contribution (DC) plan participants’ behavior when faced with one specific financial challenge: irregular expenses. Specifically, changes in credit card utilization, DC plan contributions, and/or DC plan loan use were examined after these participants experienced a significant spending “spike.” This analysis goes the next step to examine where participants who took a DC plan loan are spending that money. Key findings from this study include:
- In this sample of public-sector DC plan participants where a loan option is available, 10.9 percent took a loan during the year of interest. The likelihood of a participant taking a plan loan increased with age through the 50s then declined. Household incomes of $30,000 or above did not appear to have an impact on the likelihood of a plan loan being taken, as the percentage taking a loan in each income group was in the 10–11 percent range, and once the account balance reached $10,000, the likelihood of taking a loan was similar through balances of $100,000 or more. The percentage who took a loan increased substantially with credit card utilization, as 6.9 percent of participants in households with no outstanding credit card balances took a loan compared with 19.8 percent of those who had outstanding credit card balances equivalent to 80–100 percent of their credit card limits.
- DC plan participants in households with higher credit card usage had lower average contribution rates across all ages except for those ages 60 or older. For example, for participants in their 50s, those from households with higher credit card utilization had an average contribution rate of 4.7 percent, compared with 5.6 percent for those with lower credit card utilization. As a result, participants in households with high credit card utilization had lower average account balances.
- Among those with a new DC plan loan, health care spending was the most likely to have increased, as 58.5 percent of households where a participant took a loan saw their spending on health care increase by more than 10 percent in the year they took the loan. This was followed by travel (22.4 percent), entertainment (19.0 percent), and non-specified cash spending (18.9 percent). Comparing the spending increases by categories with those who did not take a loan, only health care spending showed a higher likelihood of having increased by more than 10 percent among those taking loans. Otherwise, spending changes were very similar between households with or without a plan loan.
- Loan usage increased among those with higher credit card utilization, which would be an indicator of households being more likely to be financially stressed. Spending increases on health care were more prevalent among the financially stressed households whose plan participants were ages 50 or older, as 63.3 percent of the households where a loan was taken had this increase compared with 56.8 percent of the households where a loan was not taken.
- In an alternative test, the share of total spending that each category represented was compared between the year prior to the loan incidence and the loan year to see if any category spending share increased by more than 5 percentage points. The spending categories most likely to have seen an increase in their share of total spending of this size were unspecified cash spending (24.9 percent of the households), health care (23.3 percent), and housing (21.0 percent).
- Only housing spending and unspecified cash spending had higher likelihoods of share increases for those taking a loan vs. those who did not. Otherwise, the likelihoods of the changes in the shares of spending in each of the other categories were either similar between the households or less for the households with a participant taking a plan loan.
- Households who started mortgage payments in the year of the loan incidence analysis were more likely to have taken a plan loan than those who did not start mortgage payments in that year — 15.6 percent vs. 10.7 percent. This was true for households with plan participants of all ages. Looking at this correlation in the opposite direction, the percentage of those having a new mortgage given that they had taken a plan loan was 5.8 percent, compared with 3.8 percent starting a new mortgage when they had not taken a plan loan. Again, a higher likelihood of starting a new mortgage for those who had taken a plan loan was found across all ages. Regardless of whether the household took a plan loan, when a new mortgage was started, the probability of having an increase in housing spending of more than 10 percent was significantly higher. For example, 60.0 percent of those who took a plan loan and started a new mortgage had a housing spending increase compared with just 6.6 percent of those without a new mortgage but having a new plan loan.
This research, like prior J.P. Morgan/EBRI studies, found that higher debt can have a long-lasting impact on retirement security, since higher credit card utilization is correlated with lower DC plan contributions and account balances. Thus, the availability of emergency savings to help cover expenses can be a critical factor in preventing or stalling a cycle of increasing debt that can significantly impact retirement readiness, wherever the individual works. Furthermore, the finding that many participants have spending increases on health care when taking a plan loan suggests that examining the health insurance available to DC plan participants could also help improve finances, showing the intersection of health and wealth. While not an emergency expense, another common reason for taking a plan loan is buying a home, which is typically a household’s largest investment. A plan loan can help reduce the borrowing costs of a home purchase or even make the home purchase possible.