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The Taxation of Retirement Saving: Choosing Between Front-Loaded and Back-Loaded Options

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Author Info

  • Burman, Leonard E.
  • Gale, William G.
  • Weiner, David

Abstract

We examine retirement savers’ choices between front-and back-loaded tax incentives, such as traditional and Roth IRAs. With equal dollar contribution limits, back-loaded plans shelter more funds than front-loaded plans. This implies that Roth IRAs can be the preferred choice even for investors who expect their tax rates to fall in retirement. Empirically, we examine how marginal tax rates have varied between 1982 and 1995 for a sample of taxpayers and calculate both ex ante and ex post effective tax rates on front-loaded IRAs. The average effective tax rate on traditional IRA contributions made in 1982 and withdrawn in 1995 was -30 percent. Changes in tax law after 1982 reduced tax rates considerably. Holding tax law constant, the average effective tax rate on IRAs was about -11 percent. These results occur because the tax rate in retirement is lower for most people than the rate while working. In contrast, the effective tax rate on Roth IRAs is always zero. Despite the lower average effective tax rate on traditional IRAs, many taxpayers in the sample would have benefited from contributing to a Roth IRA instead of a traditional IRA, due to the difference in effective contribution limits.

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Bibliographic Info

Article provided by National Tax Association in its journal National Tax Journal.

Volume (Year): 54 (2001)
Issue (Month): n. 3 (September)
Pages: 689-702

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Handle: RePEc:ntj:journl:v:54:y:2001:i:n._3:p:689-702

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  1. James M. Poterba & John B. Shoven & Clemens Sialm, 2000. "Asset Location for Retirement Savers," NBER Working Papers 7991, National Bureau of Economic Research, Inc.
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Cited by:
  1. Gaobo Pang & University of Maryland, 2006. "Tax-Deferred Savings and Early Retirement," Computing in Economics and Finance 2006 31, Society for Computational Economics.
  2. Horan, Stephen M. & Peterson, Jeffrey H., 2001. "A reexamination of tax-deductible IRAs, Roth IRAs, and 401(k) investments," Financial Services Review, Elsevier, vol. 10(1-4), pages 87-100.
  3. Richard Johnson, 2003. "Portfolio choice in tax-deferred and Roth-type savings accounts," Research Working Paper RWP 03-08, Federal Reserve Bank of Kansas City.
  4. Rydqvist, Kristian & Schwartz, Steven T. & Spizman, Joshua D., 2014. "The tax benefit of income smoothing," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 78-88.
  5. James Poterba, 2004. "Valuing Assets in Retirement Saving Accounts," NBER Working Papers 10395, National Bureau of Economic Research, Inc.

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