The latest research from the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management analyzes financial behavior among 401(k) plan participants, finding that households with spending spikes but low income are likelier to take on credit card debt and retirement plan loans.
The report, “How Financial Factors Outside of a 401(k) Plan Can Impact Retirement Readiness,” links 401(k) plan data with consumer banking data to understand how participants react to irregular spending.
Households with an unfunded spending spike were likelier to increase their credit card debt (34%) and decrease retirement plan contributions (12%) before taking a 401(k) loan (7%). Yet, households with a 401(k) loan were also much likelier to have higher credit card utilization (64% vs. 17%). These households were also likelier to have lower 401(k) balances compared to those with no credit card debt (42% vs. 71%).
According to the data, nine in 10 households experienced at least one spending spike in a given year that could not be covered by their current income, and over one in three households could not cover their increased spending with their current income and cash reserves.
EBRI and J.P. Morgan found that for three in four households with an income of under $150,000, a spending increase above $2,500 could not be financed by their salary alone.
“As expected, this research found that the lack of income and cash reserves to support spending spikes is likely to result in higher credit card debt,” explained Craig Copeland, director of wealth benefits research at EBRI. “What’s interesting is how having household credit card debt impacts the household’s retirement security, since higher credit card utilization is correlated with lower 401(k) plan contributions and account balances, even when controlling for tenure and income.”
Copeland notes how accessibility to emergency savings accounts can prevent consumers from saving less towards their retirement. EBRI and J.P. Morgan’s research finds that two to three months of net income would cover most spending spikes for consumers.
“As a result, the availability of emergency savings to cover spending spikes is a critical factor in preventing or stalling a cycle of increasing debt that can significantly impact retirement readiness,” he adds.
Ultimately, the research recommends plan sponsors inquire with a financial advisor on adding emergency savings to their plan menu, or at the very least, incorporating employee education on the subject.
Additionally, EBRI and J.P. Morgan ask employers to recognize and manage the impact of cash flow volatility within their plan. “The cause of that volatility, ‘leakage’ from plan accounts through 401(k) loans and withdrawals, can have outsized effects on retirement readiness. A focus on cash flow volatility is especially important as plan sponsors craft their Qualified Default Investment Alternative (QDIA) offering. We recommend that plan sponsors explicitly take participant behavior into account when defining criteria for their QDIA,” the research states.
“In short, what happens outside the plan – through participants’ spending and credit card usage – can exacerbate in-plan cash flow volatility and lead to less successful retirement outcomes.”
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