Healthcare, housing strains often driving use of 401(k) loans, report reveals

When workers borrow from their defined contribution plans, the money is most often directed toward healthcare or housing expenses rather than discretionary spending.

A new analysis from the Employee Benefit Research Institute and JPMorgan Asset Management argues that removing access to plan loans may be beneficial to retirement savings in the near term but may not strengthen long-term retirement outcomes since borrowers would likely turn to outside credit sources with less favorable terms.

“Workers’ finances can face many challenges over their careers, potentially leading them to have to take on debt or find other sources of financing to cover various financial challenges,” notes Craig Copeland, director, Wealth Benefits Research, EBRI. “This research focused on which expenses increased when private-sector DC plan participants took a plan loan. The expenses that stood out were health care and housing, which are essential for retirement, rather than expenses that are for current consumption.”

The study found that nearly half of households with a new 401(k) loan experienced healthcare costs rising more than 10% in the year they borrowed. Travel, entertainment and unspecified cash spending followed at much lower rates. When compared with households that did not take a loan, healthcare spending was the only category more likely to spike.

Financial stress also played a role in loan behavior and households with higher credit card utilization were more inclined to borrow. Among participants age 50 or older, 58.7% of financially stressed borrowers saw healthcare costs jump more than 10% compared with 52.5% among peers who did not take a loan.

Looking at how spending shifted overall, the categories most likely to see their share of total outlays grow by more than five percentage points were unspecified cash (22.8%), housing (21.0%) and healthcare (19.7%). Only housing and unspecified cash showed higher odds of increasing among households taking a loan.

The report also notes a clear relationship between borrowing and taking on a new mortgage.

Households beginning mortgage payments were more likely to have tapped a plan loan than those who did not start payments (12.5% versus 9.6%). Viewed the opposite way, 5.9% of plan loan borrowers had initiated a new mortgage, compared with 4.4% of non-borrowers. This pattern held across age groups.

“This research found that higher debt can have a long-lasting impact on retirement security, since higher credit card utilization is correlated with lower 401(k) plan contributions and account balances,” says Michael Conrath, chief retirement strategist, JP Morgan Asset Management. “As a result, 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. Furthermore, the finding that many participants have spending increases on healthcare when taking a plan loan suggests that examining the health savings and spending accounts available to DC plan participants could also help improve finances, showing the intersection of health and wealth.”