Spending Spikes & Student Loan Debt Are Putting Retirement Savings at Risk

Financial factors outside of workplace savings plans can have a significant impact on how employees save for retirement within plans. Two of those factors are spikes in consumer spending and student loan repayment, according to joint research conducted by the Employee Benefit Research Institute (EBRI) and J.P. Morgan Asset Management.

Spending spikes, defined as a month in which spending is at least 125% of median spending during the previous 12 months, are common across all workers, the research found. About 90% of all participants studied experienced a month in which their spending increased at least 25%, said Craig Copeland, director of wealth benefits research at EBRI during a recent webinar exploring the study findings.

Spending spikes can be fairly large: 17% of those studied doubled their spending in a single month. More than half of employees had spending spikes greater than $2,500, which EBRI noted is particularly interesting as SECURE 2.0 includes a provision that allows plan sponsors to offer employees Pension-Linked Emergency Savings Accounts (PLESA) of up to $2,500.

“While it is a start, the $2,500 limit will not cover many of these spikes and people are probably going to need more resources,” said Copeland, who suggested policies that increase that limit might be warranted.

Spending spikes go hand-in-hand with credit card utilization, said Sharon Carson, a retirement strategist at J.P. Morgan Asset Management. When spending spikes occur, people first turn to credit cards and then look to 401(k) loans to cover expenses.

The long-term effect of borrowing from a 401(k) can be significant, as loan repayments aren’t matched and employees may have difficulty repaying loans in full if they separate from their company. The research found that the more credit card debt a participant has, the lower their median retirement account balance is, a dynamic that is consistent across income levels.

Carson said plan sponsors can help by automating, incentivizing and encouraging emergency savings either in plan or out of plan. This may include implementing a match, providing education on debt management and budgeting, and taking participant behavior into account when defining criteria for Qualified Default Investment Alternatives (QDIA). She noted highly compensated employees are not eligible for PLESAs, so employers should examine whether it makes sense to offer emergency savings accounts to employees as well as whether their recordkeeper can administer them.

Student loan repayment

EBRI and J.P. Morgan also found that student loan repayments have a negative impact on 401(k) savings rates.

“If I’m an employee and I have one additional marginal dollar in my budget and I’m left with the choice of saving toward retirement or trying to pay off my student loan, that can be a tricky thing to navigate, said Michael Conrath, chief retirement strategist, J.P. Morgan Asset Management. SECURE 2.0 attempts to address this choice by allowing employers to match qualified student loan payments with a contribution to a 401(k) plan.

The report discovered that average 401(k) contribution rates were significantly higher for those making no student loan payments. Over the long term, lower contributions add up, said Conrath. Young employees making student loan payments and therefore lower 401(k) contributions could have up to $175,000 less saved when they retire than those who are able to contribute to their 401(k) because they don’t have student loan payments, the report projected.

The study further looked at whether starting or stopping student loan repayments had any impact on 401(k) contributions. About one-third of people who stopped making student loan payments increased their 401(k) contribution. Conversely, between 20 and 30% decreased their 401(k) contribution when they started paying on student loans. The median contribution rate for those also paying on student loans was 4.7%. That increased to 8% when student loan repayments stopped. Those who were not making student loan payments contributed 7% to their 401(k), which decreased to 3.5% when they started making payments.

Conrath said this dynamic highlights the value of the SECURE 2.0 student loan matching provision but warned there could be downsides.

“You may be creating incentives for people to decrease what they’re contributing, and they may not use that decrease to pay off more student loans; they may be spending it elsewhere,” said Conrath. “But if you have low contribution rates, then this could be a way to get more people into the system.”

Other strategies plan sponsors might use to help employees balance student loan debt and retirement savings is to sweep nonparticipating plan employees into the plan through automatic enrollment and implementing auto-escalation features.

Employers should recognize that employees have a lot going on in their financial lives, said Conrath.

“We see that approximately half of participants feel that they are provided with more information than they can readily absorb,” said Conrath. ”So it’s not about the quantity, it’s more about the quality of the communication. Customizing a message that is unique to a specific employee demographic not only increases the likelihood of employees opening and actually taking a look at the communication itself, but also increases the likelihood of them engaging and taking action and putting themselves on the right path toward retirement.”