Short-term spending spikes could dent workers' retirement security

A new study by the Employee Benefit Research Institute and JPMorgan Asset Management sheds light on how financial challenges, particularly irregular expenses, affect the retirement readiness of public-sector defined contribution plan participants.

The analysis builds on previous research regarding 401(k) plan participants and focuses on how public-sector workers manage spending spikes and the impact on their financial security.

EBRI's new research defines a monthly "unfunded spending spike" as a sharp increase in expenses at least 25 percent above the median spending of the previous year that cannot be covered by the household's income or available cash reserves. These blips in spending, the research found, is a reality for 29 percent of households that say they've gone through at least one of those financial speed bumps.

Among those with incomes of $150,000 or less, 60 percent faced spikes that surpassed $2,500 in a year, which they could not cover with income or cash alone. And while participants with higher gross incomes were less likely to experience sudden increases in spending, nearly one-quarter of those earning $100,000 or more still reported experiencing spending spikes.

The data highlight a clear relationship between these spending spikes and increased reliance on both credit card debt and plan loans. “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,” EBRI said, compared to lower percentages among those without spikes.

The research found households are more likely to use credit cards before dipping into their 401(k)s. Among households that reported using less than 80 percent of the allowable credit on their cards, 37 to 47 percent reported borrowing more on their credit cards in response to an unexpected spending bump, and just 8 percent said they borrowed from their 401(k).

“When credit card utilization reached 80 percent or more, the likelihood of increasing credit card debt decreased to 22.4 percent,” the EBRI researchers said, while new plan loans increased to 11.5 percent for those in this category.

By taking on more debt, 401(k) plan participants could be putting their retirement at risk, particularly as higher credit card use is linked to lower DC plan contributions and balances.

"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," EBRI concluded.