Summary
- Research supports idea that prohibiting plan loans would not necessarily improve participants’ retirement security, as the loan usage is more likely to help with expenses that impact retirement -
(Washington, D.C.) – A new research report, “Where Are Households Spending Their Defined Contribution Plan Loans: An Examination of Private-Sector Participants,” published today by the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management, found health care and housing spending, particularly among the households starting a new mortgage, stood out as sources of spending increases when households take a defined contribution (DC) plan loan. This supports the idea that prohibiting plan loans would not necessarily improve participants’ retirement security, as the loan is more likely to help with expenses — health care and homes — that impact retirement. Without the option of taking a plan loan, participants would seek loans outside the plan to fill these spending gaps, and those loans may have terms less favorable than those of a plan loan.
“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 various financial challenges. This research focused on which expenses increased when private-sector DC plan participants took a plan loan. The expenses that stood out were health care and housing, which are essential for retirement, rather than expenses that are for current consumption. Consequently, the plan loan could negatively impact retirement savings in the near term, but it could help the participants’ financial status in the long term by addressing expenses that can carry over to retirement and doing it in a manner that is more efficient for the participant,” said Craig Copeland, director, Wealth Benefits Research, EBRI.
Key findings in the new report include:
• Among those with a new 401(k) plan loan, health care spending was the most likely to have increased, as 47.6% of households where a participant took a loan saw their spending on health care increase by more than 10% in the year they took the loan. This was followed by travel (21.7%), entertainment (20.2%) and non-specified cash spending (20.0%). 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% 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 is 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 years old or older, as 58.7% of the households where a loan was taken had this increase compared with 52.5% of the households where a loan was not taken.
• The study also looked to see if any category spending share increased by more than 5 percentage points from the year prior. The spending categories most likely to have seen an increase in their share of total spending of this size were unspecified cash spending (22.8% of the households), housing (21.0%) and health care (19.7%).
• Only housing spending and unspecified cash spending had higher likelihoods of share increases for those taking a loan versus 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 — 12.5% compared with 9.6%. 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 5.9%, compared with 4.4% 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.
“This research found that higher debt can have a long-lasting impact on retirement security, since higher credit card utilization is correlated with lower 401(k) plan contributions and account balances. As a result, 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,” said Michael Conrath, chief retirement strategist, J.P. Morgan Asset Management. “Furthermore, the finding that many participants have spending increases on health care when taking a plan loan suggests that examining the health savings and spending accounts available to DC plan participants could also help improve finances, showing the intersection of health and wealth.”