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New evidence on 401(k) borrowing and household balance sheets

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  • Geng Li
  • Paul A. Smith
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Abstract

Despite news reports suggesting a rise in 401(k) borrowing in recent years, we find that the share of eligible households with 401(k) loans in the 2007 Survey of Consumer Finances was about 15 percent, roughly what it has been since 1995. We find that the best predictors of 401(k) borrowing appear to be the presence of liquidity or borrowing constraints and the size of 401(k) balances relative to income. Since the ongoing financial crisis has likely caused these factors to move in opposite directions, the predicted effect of the crisis on 401(k) borrowing is ambiguous. More fundamentally, we find that many loan-eligible households carry relatively expensive consumer debt that could be more economically financed via 401(k) borrowing. In the aggregate, we estimate that such households could have saved as much as $5 billion in 2007 by shifting expensive consumer debt to 401(k) loans. This would translate into annual savings of about $275 per household—roughly 20 percent of their overall interest costs--with larger reductions for households that carry consumer debt at high interest rates or who hold larger 401(k) balances. We posit that households might utilize 401(k) loans less than expected due to risk-aversion, self-control problems, and confusion about the potential gains, and suggest better financial education that clarifies the conditions under which 401(k) borrowing is advantageous. Finally, we note that allowing households to repay 401(k) loans gradually even after separation from their employers could improve household welfare by reducing the risks of 401(k) borrowing.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2009-19.

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Date of creation: 2009
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Handle: RePEc:fip:fedgfe:2009-19

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Related research

Keywords: 401(k) plans ; Consumer credit;

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References

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  1. Marianne Bertrand & Dean Karlan & Sendhil Mullainathan & Eldar Shafir & Jonathan Zinman, 2010. "What's Advertising Content Worth? Evidence from a Consumer Credit Marketing Field Experiment," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 263-305, February.
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  4. Marianne Bertrand & Dean S. Karlan & Sendhil Mullainathan & Eldar Shafir & Jonathan Zinman, 2005. "What's Psychology Worth? A Field Experiment in the Consumer Credit Market," Working Papers 918, Economic Growth Center, Yale University.
  5. Irina A. Telyukova & Randall Wright, 2007. "A model of money and credit, with application to the credit card debt puzzle," Working Paper 0711, Federal Reserve Bank of Cleveland.
  6. Bergstresser, Daniel & Poterba, James, 2004. "Asset allocation and asset location: household evidence from the survey of consumer finances," Journal of Public Economics, Elsevier, vol. 88(9-10), pages 1893-1915, August.
  7. Amromin, Gene & Huang, Jennifer & Sialm, Clemens, 2007. "The tradeoff between mortgage prepayments and tax-deferred retirement savings," Journal of Public Economics, Elsevier, vol. 91(10), pages 2014-2040, November.
  8. Telyukova, Irina, 2008. "Household Need for Liquidity and the Credit Card Debt Puzzle," University of California at San Diego, Economics Working Paper Series qt4c67r71r, Department of Economics, UC San Diego.
  9. Brigitte C. Madrian & Dennis F. Shea, 2000. "The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior," NBER Working Papers 7682, National Bureau of Economic Research, Inc.
  10. Olivia S. Mitchell & Stephen P. Utkus & Tongxuan (Stella) Yang, 2005. "Turning Workers into Savers? Incentives, Liquidity, and Choice in 401(k) Plan Design," NBER Working Papers 11726, National Bureau of Economic Research, Inc.
  11. Esther Duflo & William Gale & Jeffrey Liebman & Peter Orszag & Emmanuel Saez, 2005. "Saving Incentives for Low- and Middle-Income Families: Evidence from a Field Experiment with H&R Block," NBER Working Papers 11680, National Bureau of Economic Research, Inc.
  12. Love, David, 2006. "Buffer stock saving in retirement accounts," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1473-1492, October.
  13. Annamaria Lusardi & Olivia S Mitchelli, 2007. "Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education," Business Economics, Palgrave Macmillan, vol. 42(1), pages 35-44, January.
  14. Esther Duflo & Emmanuel Saez, 2000. "Participation and Investment Decisions in a Retirement Plan: The Influence of Colleagues' Choices," NBER Working Papers 7735, National Bureau of Economic Research, Inc.
  15. Geng Li & Paul A. Smith, 2008. "Borrowing from yourself: 401(k) loans and household balance sheets," Finance and Economics Discussion Series 2008-42, Board of Governors of the Federal Reserve System (U.S.).
  16. repec:fth:pennfi:69 is not listed on IDEAS
  17. Barber, Brad M. & Odean, Terrance, 2004. "Are individual investors tax savvy? Evidence from retail and discount brokerage accounts," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 419-442, January.
  18. Love, David A., 2007. "What can the life-cycle model tell us about 401(k) contributions and participation?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 6(02), pages 147-185, July.
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