Summary
Workers’ finances can face many challenges over their careers, including irregular expenses, which are sometimes quite large. How workers deal with covering these expenses and how they affect other aspects of their financial goals are ripe areas of analysis, particularly with respect to retirement preparations. This study builds on prior work done by the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management focused on 401(k) plan participants’ behavior when faced with irregular expenses. This analysis examines the behavior of public-sector defined contribution (DC) plan participants on the tradeoff between credit card debt and a plan loan. Key findings from the study:
- A monthly unfunded spending spike is defined as a spike at least 25 percent above the previous 12 months’ median spending that cannot be funded by the household’s income and available cash reserves in that month. In this study, 29 percent of the household observations were found to have had at least one month where an unfunded spending spike occurred.
- On a dollar basis, among those with incomes of $150,000 or less, 60 percent of the household observations had spikes not covered by income and cash reserves larger than $2,500 aggregated over the year, and 82 percent had spending not covered by income alone above this threshold.
- The likelihood of experiencing a spike increased with the spending ratio and beginning-of-the-year credit card utilization. In contrast, the likelihood of a spike decreased as gross income increased. However, nearly one-quarter of the households with incomes of $100,000 or more had a spike, so these spikes do not only occur among those with lower incomes.
- These spending spikes have a clear impact on the likelihood of public-sector DC plan participants taking a plan loan and increasing their credit card debt in the year of the spike. Of those with a spending spike in the analysis year, 7.0 percent took a new plan loan and 31.7 percent increased their credit card debt, compared with 2.7 percent and 25.9, respectively, of those without a spending spike in that same year.
- Households are more likely to take on additional credit card debt before taking the plan loan, as approximately 37–47 percent of those with credit card utilization of >0–79 percent increased their credit card debt, while less than 8 percent took a new plan loan with that level of credit card utilization. However, when credit card utilization reached 80 percent or more, the likelihood of increasing credit card debt decreased to 22.4 percent, while the increasing trend of taking a new plan loan went up by nearly twice the amount it had before the increase to 80–100 percent at 11.5 percent.
This research found that, like private-sector DC plan participants, public-sector DC plan participants who lack income and cash reserves to support a spending spike are likely to end up with more credit card debt. This 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, even when controlling for income. Thus, the availability of emergency savings to cover spending spikes can be a critical factor in preventing or stalling a cycle of increasing debt that can significantly impact retirement readiness, wherever the individual works.