Borrowing from Yourself: The Determinants of 401(K) Loan Patterns

Abstract

This paper explores the determinants of people's decisions to take 401(k) loans. We argue that 401(k) plans do not simply represent retirement saving, but they also provide a means of saving for precautionary purposes. We model factors that rationally would induce people to borrow from their pension plans, and we explain why people do not often use 401(k) loans to replace their more expensive credit card debt. Next we test our hypotheses using a rich dataset and show that people who are liquidity-constrained are more likely to have plan loans, while the better-off take larger loans when they do borrow. Plan characteristics such as the number of loans allowed also influence borrowing and loan size in interesting ways, while loan interest rates have only a small impact.

The Availability and Utilization of 401(K) Loans

“…However, the size of loans that do get taken out are slightly larger (4 percent of total balances) in plans that charge more than prime plus one than in plans that charge the prime rate. Lu and Mitchell (2010) also fi nd that a higher loan interest rate is related to a lower probability of having a 401(k) loan, but a higher loan balance conditional on having a loan. Imposing a maximum general purpose loan duration of less than fi ve years is associated with a decrease in loan size of 2 percent of total balances, and allowing more loans outstanding is associated with larger loan-to-balance ratios.…”

“…The loan-to-total balance ratio is hump-shaped with respect to age and increasing with respect to compensation, rather than decreasing with respect to these variables. Using administrative data from Vanguard, Lu and Mitchell (2010) fi nd similar relationships between demographic characteristics and loan utilization. The patterns of the demographic coefficients do not change much when the plan feature controls are added.…”

“… Utkus and Young (2010). andLu and Mitchell (2010) report that a similarly high fraction of loans in Vanguard-administered savings plans are general purpose loans.…”

The Consumption and Wealth Effects of an Unanticipated Change in Lifetime Resources

“…The paper takes these contractual features as given, and studies the wealth and consumption effects of a reduction in severance pay entitlements. A recent literature studies how consumers respond to the option to cash out retirement savings (Agarwal, Pan and Qian, 2014), the incentives to borrow from their pension plans (Lu and Mitchell, 2010;Beshears et al, 2011b), the effect of default options on retirement Brugiavini (2002) and Bottazzi, Jappelli and Padula (2006) provide more detail on the pension reform.…”

At the Corner of Main and Wall Street: Family Pension Responses to Liquidity Change and Perceived Returns

“…Yet, the financial crisis, while an important factor in motivating withdrawals from pension balances, is part of a wider pattern of pre-retirement pension transactions. We would like to understand this wider set of factors that lead a family to withdraw funds or 'borrow' from their pensions prior to retirement (Lu and Mitchell, 2010). Our prior research shows that much of the rise and subsequent mortgage difficulties were concentrated among younger and less educated homeowners.…”