Summary
A new research report, “Where Are Households Spending Their Defined Contribution Plan Loans: An Examination of Public-Sector Participants,” published today by the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management, found spending increases in many different categories among households with participants taking a defined contribution (DC) plan loan. Yet, health care and housing spending, particularly among the households starting a new mortgage, stood out as places where spending increases were more likely to occur than in households where a plan loan was not taken.
“Loan usage does not appear to be tied to spending on luxury items but has more to do with their health care or investing in a home. This supports that prohibiting plan loans would not necessarily improve participants’ retirement security, as the loan usage is more likely to help with expenses that would impact retirement — health and homes. Without the option of taking a plan loan, participants would seek loans outside the plan to fill spending gaps, and those loans may have terms more expensive than those of a plan loan,” said Craig Copeland, director, Wealth Benefits Research, EBRI. “Yet, having liquid accounts, such as health savings accounts and emergency savings accounts that can provide funds for health care or housing, could help limit DC plan participants’ need to tap into their retirement savings accounts when faced with health events or when investing in or repairing their homes.”
Key findings in the new report include:
• In this sample of public-sector DC plan participants where a loan option is available, 10.9% took a loan in the year studied. The likelihood of a participant taking a plan loan increased with age through their 50s then declined, while household income did not appear to have an impact on the likelihood of taking a plan loan. The percentage who took a loan increased substantially with credit card utilization, as 6.9% of participants in households with no outstanding credit card balances took a loan compared with 19.8% of those who have outstanding credit card balances equivalent to 80–100% of their credit card limits.
• Among those with a new DC plan loan, health care spending was the most likely to have increased, as 58.5% 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 (22.4%), entertainment (19%) and non-specified cash spending (18.9%). 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.
• Spending increases on health care were more prevalent among the “financially stressed” households whose plan participants were ages 50 or older, as 63.3% of the households where a loan was taken had this increase compared with 56.8% 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 five 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% of the households), health care (23.3%) and housing (21%).
• 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 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% vs. 10.7%. 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% compared with 3.8% 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.
• DC plan participants in households with higher credit card usage have lower average contribution rates across all ages except for those ages 60 or older. As a result, participants in households with high credit card utilization have lower average account balances.
“This new report finds 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. 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. “Additionally, we observed that participants who take plan loans often see an increase in health care spending. This suggests that reviewing the types of health insurance and cost-sharing options available to DC plan participants could help strengthen their financial well-being, underscoring the connection between health and wealth.”