Easy Money or Hard Times? Health and 401 (K) Loans

Article excerpt


Medical debt has become increasingly commonplace. Frequently, households rely on debt to finance health care; as health insurance coverage has declined, out-of-pocket expenditures have increased and health care costs have risen. Loans from defined contribution (DC) retirement savings plans, such as 401 (k) plans, are among the most easily accessed resources because savers act as lenders to themselves. As DC plans have become more prevalent, households have increased access to this type of loan. Not only has the prevalence of DC plans increased, account balances have grown and more employers offer the option to borrow from DC plans to their employees. All of these factors increase a household's ability to borrow from itself.

The financing of unexpected emergencies, such as medical care, is one reason for allowing loans from tax-advantaged retirement accounts. The logic is that households will accrue savings in their retirement accounts faster if they know that they can access those funds in an emergency. On the other hand, rising medical debt is one of the most consistent predictors of personal bankruptcy. The personal bankruptcy rate has risen over the decades along with growing personal debt, especially medical debt.

The ease with which DC loans can be accessed, though, may mean that these loans are used for a variety of consumption purposes, including all kinds of goods and services. It is possible that DC loans are systematically related to a number of factors other than health status, for instance, homeownership or educational levels.

Understanding the reasons why people borrow from their retirement plans has clear policy implications. DC loans may pose a dilemma for policymakers if these loans are related to health status and health insurance coverage. The money in such accounts is intended to supplement other retirement income. A number of federal tax incentives support this goal. People may borrow from their DC plans to pay for their health care. However, borrowing is likely to result in a reduction in their retirement savings and may increase their chance of future bankruptcy. More DC loans may consequently reduce immediate hardships for households, but increase future financial insecurity.

In this article, we focus on the relationship between health status, access to health insurance, and the likelihood of having a DC loan and the loan amount. We find that households with a household member in poor health are more likely to borrow, and borrow larger amounts, from their DC plans than do healthy households. Health status is, in fact, as important as or even more important than other potential reasons for DC loans--such as education and home-ownership. The link between health status and DC loans remains after we control for health insurance coverage. Even those households with health insurance tend to systematically increase their probability of borrowing from DC plans when a family member is in bad health.

The rest of the article is organized as follows. We provide an overview of the relevant literature in Section II, followed by a discussion of some summary data in Section III. Our multivariate analyses of the links between health status, health insurance coverage, and DC loans follow in Section IV. Section V contains our concluding remarks.


A. Effects of DC Loans

DC account loans are an odd sort of loan. The odd part of these loans is that credit approvals and the ability to pay back the loan are not subject to outside review. With this type of loan, the borrower is also the banker, albeit within some limits (GAO 1997). People with a DC plan may borrow $50,000 or one-half of the vested balance from the account, whichever is lower. Loans must be repaid within 5 years, except for the loans used for the first-time purchase of a home, which can be repaid over 15 years.

The interest rates on these loans are generally favorable. …