Credit card debt can cut your retirement savings in half.
A recent study penned by J.P. Morgan Asset Management and the Employee Benefit Research Institute examined how spending and credit card debt affects overall retirement savings. Each aspect of a household’s finances affect every other, so behavior in one aspect of financial life may indicate performance in another: like abnormal spending spikes and the health of one’s retirement savings.
While it’s somewhat expected that the more often a household faces unexpected spending, the more their retirement accounts suffer, it’s the magnitude of this impact is noteworthy, because debt and spending can cut a household’s retirement accounts in half.
A financial advisor can help you manage debt and build a retirement plan. Speak to an advisor today.
Half of Households Can’t Handle Spending Spikes
A “spending spike” was defined as an unfunded burst of expenses not covered by ordinary income and cash on hand. Basically, this is spending beyond what a household can cover from their paycheck or excess cash in the checking account.
Among households with an active 401(k) account, they found that almost every household has at least one burst of spending each year that they can’t cover with that month’s paycheck. For roughly one-third of this cohort, that spending spike exceeded both their paycheck and their ordinary cash reserves. These households had lower income, more credit card debt and a higher likelihood of withdrawing money via a 401(k) loan.
What’s more, this appears to be a pervasive issue. The results applied to households making up to double the median income. “For three in four households with income under $150,000,” they wrote, “a spending increase above $2,500 could not be funded by income alone.”
And this spending has a serious, lasting effect on retirement savings.
If you’re looking to establish a path to your financial goals, a financial advisor can help.
How Spending Spikes Interrupt Retirement Savings
When households experience a spending spike, suddenly needing money beyond what they have on hand, almost all of them respond in three ways:
- Credit card debt
- Taking a 401(k) loan
- Cutting 401(k) contributions
All of these can have a serious impact on long-term retirement savings.
The latter two approaches can lead to real, potentially even significant, drops in your long-term retirement savings. While in theory, 401(k) loans don’t necessarily harm retirement savings, the more often you take a 401(k) loan the less likely you are to contribute to your retirement account overall.
It’s the credit cards that really bite into retirement savings though.
This is the go-to for most households when a spending spike hits. Almost half of all households raise cash by putting an unexpected bill on their credit card, and those credit card bills correlate directly with much, much lower rates of retirement savings. The more money someone owes on their credit card, the less they tend to put towards their retirement. Among households with low credit utilization, the median retirement contribution is 9% of income, a very healthy percentage right in line with most financial advice. Among households with high utilization, the median contribution is 5%.
Which is probably why low-utilization households have much, much more saved. Households with low credit utilization have a median $184,360 in their 401(k) accounts. Households with high utilization?
They hold just under $80,000.
The Bottom Line
There are two major takeaways here. First, households and financial advisors alike should take credit card debt as a red flag for retirement security. The more you owe on your credit card, the more you should pay attention to your retirement account, because there’s a good chance that you have neglected one in favor of the other.
Second, build up an emergency fund. For people with employer-sponsored retirement plans, such as a 401(k), the SECURE 2.0 Act has also created a tax-advantaged emergency fund. As is the case with all elements of the retirement system, this significantly advantages households with W-2 employment over all other households, but it is still quite valuable. Employers should consider offering this program and, whenever possible, employees should take advantage of it.
Credit Card Management Tips
- Managing credit card debt can be difficult, but you can do it. Let’s start by studying how our advisor helped one reader with their $31,000 bill.
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.