Borrowers taking loans from defined contribution plans are mostly likely to use the money for healthcare or housing expenses than for luxuries, according to a new research report from the Employee Benefit Research Institute and JP Morgan Asset Management.
In a sample of public-sector defined contribution plan participants where loan options are available, 10.9% took a loan in the year studied. Among those with a new defined contribution plan loan, their healthcare spending was the most likely to have increased by more than 10% in the year they took the loan, necessitating the need for funds, according to the study.
“Loan usage does not appear to be tied to spending on luxury items but has more to do with their healthcare 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,” Craig Copeland, director of wealth benefits research at EBRI, said in a statement.
“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,” he continued. “Yet having liquid accounts, such as health savings accounts and emergency savings accounts that can provide funds for healthcare 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.”
Loan usage was higher among borrowers who used their credit cards the most, which the authors said could indicate that those households were “financially stressed.”
The likelihood of participants taking a defined contribution plan loan increased with age until people entered their 50s, and then tapered off, according to the study.
Having a household income of $30,000 or more did not appear to influence the likelihood of a loan being taken.
“This research, like prior JP 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,” the authors concluded. “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 healthcare 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,” they added.