Nearly one in three public sector employee households (29%) experience spending spikes that threaten their financial stability and retirement preparedness, according to new research published by J.P. Morgan Asset Management and the Employee Benefit Research Institute.
The study highlights the importance of supplemental defined contribution plans in bridging the gap for public employees, especially those reliant on defined benefit plans. It also provides actionable steps for public employers to enhance their employees’ financial security and retirement preparedness.
“It is clear that spending, debt and saving for retirement are explicitly linked. This study builds on the prior J.P. Morgan/EBRI study that looked at the links between these actions among private sector DC plan participants to determine if the same links are found among public sector DC plan participants and found that the same relationships exist among these workers as well,” said Craig Copeland, director, Wealth Benefits Research, EBRI.
The links between spending and debt suggests that retirement planning is not wholly different by place of employment, even where benefits availability may be dissimilar, but part of a broader holistic financial planning journey where all factors need to be incorporated, Copeland added.
“Programs to help with workers’ overall finances could be indispensable,” he said. “The decision to a take a plan loan is not just dependent on what happens in the plan but on the total financial profile of the participant.”
Key Findings:
- 30% of public employee households face spending spikes exceeding their income and savings, leading to increased credit card debt and retirement plan loans.
- Both lower-income and higher-income households are affected.
- High credit card utilization and plan loans result in lower retirement contributions. On average, those without credit card debt contributed 6.1% of their salary to their DC plans, compared to those with nearly maxed out credit cards (utilizing 80% to 100% of their available credit), who contributed 4.8%, on average.
The research found participants who experienced unfunded spending “spikes” were more likely to have increased credit card debt and to have taken a DC plan loan. Those with a higher percentage of their available credit card debt being used had lower contributions and lower account balances, on average.
Spending spikes occur when a household’s monthly spending is at least 25% or more than the previous 12 months’ median monthly spending and this spending cannot be covered by the household’s income and cash reserves (checking and savings accounts). Nearly one-third (29%) of the public sector DC plan participants were found to have these spikes in the study year, and they were not among just those with lower incomes as nearly one-quarter of those with incomes of $100,000 or more experienced a spike.
“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.”
Sharon Carson, J.P. Morgan Asset Management
These spending spikes have a clear impact on the likelihood of 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% took a new plan loan and 31.7% increased their credit card debt, compared with 2.7% and 25.9%, respectively, of those without a spending spike in the same year.
Households are more likely to take on additional credit card debt before taking the plan loan, as approximately one-third to one half of those with credit card utilization of less than 80% increased credit card debt, while less than 8% took a new plan loan with that level of credit card utilization. However, when credit card utilization reaches 80%, the likelihood of increasing credit card debt decreases to 22.4%, while the percentage taking a new plan loan increases to 11.5%.
“Given the impact of participants’ overall finances, it is clear that prohibiting plan loans would not necessarily improve participants’ retirement security. Without the option, participants would seek loans outside the plan to fill spending gaps, and those loans may have terms more expensive than those available as part of the plan,” said Sharon Carson, executive director and retirement strategist, J.P. Morgan Asset Management. “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.”
5 key takeaways for public employers
What happens outside the plan—through spending and credit card usage—can lead to less successful retirement outcomes. Plan sponsors need to recognize this, and help their employees manage these challenges.
The report suggests the following actionable ideas:
1. Take participant behavior into account when selecting investments for DC plans. Specifically, realize that participants will have spending variations, and that taking out plan loans when they are nearing retirement may result in sequence-of-return risk. Consequently, care should be taken not to overweight inflation risk at the end of the glide path.
2. Some employers may want to consider in-plan retirement income options. For public employers that are concerned their DB plan may offer inadequate retirement income, flexible guaranteed income in their DC plan may provide a source for employees’ stable expenses, while other assets provide for their variable spending.
3. Help employees determine how much they should contribute to supplemental DC plans. Public employees may not realize how important supplemental DC plans are for their retirement readiness. Giving them a gauge helps.
4. Provide education on debt management and emergency savings. For plans with loan provisions, target employees who have taken loans.
5. Automate, incentivize and/or encourage emergency savings. This will help employees avoid credit card debt and plan loans.
Public policy implications
Although the SECURE 2.0 legislation likely did not intend to leave out public employees, its emergency savings provision does not apply to public plans. This is an important matter for lawmakers to revisit.
The research paper recommends that policymakers:
• Add an emergency savings provision for public plan employees. The emergency savings provision in the SECURE 2.0 legislation only provides for $1,000 penalty-free hardship withdrawals for public plan employees. Lawmakers may want to correct this by adding an emergency savings provision for 457 plans.
• Consider a higher limit for emergency accounts. The emergency account limit set by SECURE 2.0—$2,500—is smaller than many of the unfunded spending spikes that EBRI/JPMAM’s earlier research found many people experienced in the private sector. For those employed in the public sector, the latest research found that even more employees with income of $150,000 or less had even bigger spikes.
The data analyzed for the research study came from the PRRL Database and JPMorgan Chase Bank, N.A. The PRRL Database is an opt-in collaboration among public retirement plan sponsors, EBRI and NAGDCA. It includes information from 267 different 457(b), 401(a), 401(k) and 403(b) defined contribution plans, representing 2.5 million state, county, city and subdivision government employees and incorporating over 3 million retirement accounts valued at $170 billion in assets (as of year-end 2021).
The study population was financially diverse, with an average age of 43 and average annual gross household income of $85,000.
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