Advanced Search
MyIDEAS: Login to save this book chapter or follow this series

The tradeoff between mortgage prepayments and tax-deferred retirement savings

In: Trans-Atlantic Public Economics Seminar (TAPES), Public Policy and Retirement

Contents:

Author Info

  • Gene Amromin
  • Jennifer Huang
  • Clemens Sialm

Abstract

We show that a significant number of households can perform a tax arbitrage by cutting back on their additional mortgage payments and increasing their contributions to tax-deferred accounts (TDA). Using data from the Survey of Consumer Finances, we show that about 38% of U.S. households that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making the wrong choice. For these households, reallocating their savings can yield a mean benefit of 11 to 17 cents per dollar, depending on the choice of investment assets in the TDA. In the aggregate, these mis-allocated savings are costing U.S. households as much as 1.5 billion dollars per year. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity considerations and that self-reported debt aversion and risk aversion variables explain to some extent the preference for paying off debt obligations early and hence the propensity to forgo our proposed tax arbitrage.

(This abstract was borrowed from another version of this item.)

Download Info

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Bibliographic Info

as in new window

This chapter was published in:

  • Sören Blomquist & Roger Gordon, 2007. "Trans-Atlantic Public Economics Seminar (TAPES), Public Policy and Retirement," NBER Books, National Bureau of Economic Research, Inc, number blom07-1, July.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 4363.

    Handle: RePEc:nbr:nberch:4363

    Contact details of provider:
    Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Email:
    Web page: http://www.nber.org
    More information through EDIRC

    Related research

    Keywords:

    Other versions of this item:

    Find related papers by JEL classification:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Gary V. Engelhardt & Anil Kumar, 2006. "Employer Matching and 401(k) Saving: Evidence from the Health and Retirement Study," DNB Working Papers, Netherlands Central Bank, Research Department 079, Netherlands Central Bank, Research Department.
    2. Esther Duflo & Emmanuel Saez, 2003. "The Role Of Information And Social Interactions In Retirement Plan Decisions: Evidence From A Randomized Experiment," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 118(3), pages 815-842, August.
    3. John Y. Campbell, 2006. "Household Finance," Journal of Finance, American Finance Association, American Finance Association, vol. 61(4), pages 1553-1604, 08.
    4. Jerry Green & John B. Shoven, 1983. "The Effects of Interest Rates on Mortgage Prepayments," NBER Working Papers 1246, National Bureau of Economic Research, Inc.
    5. Poterba, James & Rauh, Joshua & Venti, Steven & Wise, David, 2007. "Defined contribution plans, defined benefit plans, and the accumulation of retirement wealth," Journal of Public Economics, Elsevier, Elsevier, vol. 91(10), pages 2062-2086, November.
    6. Jeffrey R. Brown & Nellie Liang & Scott Weisbenner, 2007. "Individual Account Investment Options and Portfolio Choice: Behavioral Lessons from 401(k) Plans," NBER Working Papers 13169, National Bureau of Economic Research, Inc.
    7. Shefrin, Hersh M & Thaler, Richard H, 1988. "The Behavioral Life-Cycle Hypothesis," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 26(4), pages 609-43, October.
    8. Karen M. Pence, 2002. "401(k)s and household saving: new evidence from the Survey of Consumer Finances," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2002-6, Board of Governors of the Federal Reserve System (U.S.).
    9. James J. Choi & David Laibson & Brigitte C. Madrian, 2004. "Plan Design and 401(k) Savings Outcomes," NBER Working Papers 10486, National Bureau of Economic Research, Inc.
    10. Nicholas Barberis & Richard Thaler, 2002. "A Survey of Behavioral Finance," NBER Working Papers 9222, 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. Julie Agnew & Pierluigi Balduzzi & Annika Sundén, 2003. "Portfolio Choice and Trading in a Large 401(k) Plan," American Economic Review, American Economic Association, American Economic Association, vol. 93(1), pages 193-215, March.
    13. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, Elsevier, vol. 29(1), pages 97-112, March.
    14. Cunningham, Christopher R. & Engelhardt, Gary V., 2002. "Federal Tax Policy, Employer Matching, and 401(k) Saving: Evidence from HRS W-2 Records," National Tax Journal, National Tax Association, vol. 55(3), pages 617-45, September.
    15. Mark Grinblatt & Matti Keloharju, 2000. "What Makes Investors Trade?," Yale School of Management Working Papers, Yale School of Management ysm146, Yale School of Management, revised 01 Nov 2001.
    16. James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2002. "For Better or For Worse: Default Effects and 401(k) Savings Behavior," JCPR Working Papers, Northwestern University/University of Chicago Joint Center for Poverty Research 256, Northwestern University/University of Chicago Joint Center for Poverty Research.
    17. David B. Gross & Nicholas S. Souleles, 2001. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," NBER Working Papers 8314, National Bureau of Economic Research, Inc.
    18. Arthur B. Kennickell & Martha Starr-McCluer, 1994. "Changes in family finances from 1989 to 1992: evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.), issue Oct, pages 861-882.
    19. John Y. Campbell & Joao F. Cocco, 2003. "Household Risk Management And Optimal Mortgage Choice," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 118(4), pages 1449-1494, November.
    20. James M. Poterba, 2001. "Taxation, Risk-Taking, and Household Portfolio Behavior," NBER Working Papers 8340, National Bureau of Economic Research, Inc.
    21. James J. Choi & David Laibson & Brigitte C. Madrian & Andrew Metrick, 2002. "Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance," JCPR Working Papers, Northwestern University/University of Chicago Joint Center for Poverty Research 257, Northwestern University/University of Chicago Joint Center for Poverty Research.
    22. White, Michelle J, 1998. "Why Don't More Households File for Bankruptcy?," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 14(2), pages 205-31, October.
    23. James J. Choi & David Laibson & Brigitte C. Madrian, 2005. "$100 Bills on the Sidewalk: Suboptimal Saving in 401(k) Plans," Levine's Bibliography 784828000000000649, UCLA Department of Economics.
    24. Kenneth B. Dunn & Chester S. Spatt, 1999. "Call Options, Points, and Dominance Restrictions on Debt Contracts," Journal of Finance, American Finance Association, American Finance Association, vol. 54(6), pages 2317-2337, December.
    25. Brigitte C. Madrian & Dennis F. Shea, 2001. "THE POWER OF SUGGESTION: INERTIA IN 401(k) PARTICIPATION AND SAVINGS BEHAVIOR," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(4), pages 1149-1187, November.
    26. White, M.J., 1998. "Why Don't More Households File for Bankruptcy?," Papers, Michigan - Center for Research on Economic & Social Theory 98-03, Michigan - Center for Research on Economic & Social Theory.
    27. Richard H. Thaler & Shlomo Benartzi, 2001. "Naive Diversification Strategies in Defined Contribution Saving Plans," American Economic Review, American Economic Association, American Economic Association, vol. 91(1), pages 79-98, March.
    28. Robert M. Dammon & Chester S. Spatt & Harold H. Zhang, 2004. "Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing," Journal of Finance, American Finance Association, American Finance Association, vol. 59(3), pages 999-1037, 06.
    29. Bernheim, B. Douglas, 2002. "Taxation and saving," Handbook of Public Economics, Elsevier, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 18, pages 1173-1249 Elsevier.
    30. Qiang Fu & Michael Lacour-Little & Kerry D. Vandell, 1997. "Retiring Early: an Empirical Analysis of the Mortgage Curtailment Decision," Wisconsin-Madison CULER working papers, University of Wisconsin Center for Urban Land Economic Research 97-09, University of Wisconsin Center for Urban Land Economic Research.
    31. James J. Heckman, 1976. "The Common Structure of Statistical Models of Truncation, Sample Selection and Limited Dependent Variables and a Simple Estimator for Such Models," NBER Chapters, National Bureau of Economic Research, Inc, in: Annals of Economic and Social Measurement, Volume 5, number 4, pages 475-492 National Bureau of Economic Research, Inc.
    32. James J. Choi & David Laibson & Brigitte C. Madrian, 2011. "$100 Bills on the Sidewalk: Suboptimal Investment in 401(k) Plans," The Review of Economics and Statistics, MIT Press, vol. 93(3), pages 748-763, August.
    33. Clemens Sialm, 2006. "Investment Taxes and Equity Returns," NBER Working Papers 12146, National Bureau of Economic Research, Inc.
    34. Haliassos, Michael & Reiter, Michael, 2005. "Credit card debt puzzles," CFS Working Paper Series 2005/26, Center for Financial Studies (CFS).
    35. Daniel Feenberg & Elisabeth Coutts, 1993. "An introduction to the TAXSIM model," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 12(1), pages 189-194.
    36. John B. Shoven & Clemens Sialm, 1999. "Asset Location in Tax-Deferred and Conventional Savings Accounts," NBER Working Papers 7192, National Bureau of Economic Research, Inc.
    37. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(4), pages 825-853, August.
    38. Gur Huberman & Wei Jiang, 2006. "Offering versus Choice in 401(k) Plans: Equity Exposure and Number of Funds," Journal of Finance, American Finance Association, American Finance Association, vol. 61(2), pages 763-801, 04.
    39. James M. Poterba, 2000. "Stock Market Wealth and Consumption," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 14(2), pages 99-118, Spring.
    40. Scott Fay & Erik Hurst & Michelle J. White, 2002. "The Household Bankruptcy Decision," American Economic Review, American Economic Association, American Economic Association, vol. 92(3), pages 706-718, June.
    41. Poterba, James M. & Venti, Steven F. & Wise, David A., 1995. "Do 401(k) contributions crowd out other personal saving?," Journal of Public Economics, Elsevier, Elsevier, vol. 58(1), pages 1-32, September.
    42. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, American Finance Association, vol. 56(4), pages 1533-1597, 08.
    43. Hilary W. Hoynes & Daniel L. McFadden, 1996. "The Impact of Demographics on Housing and Nonhousing Wealth in the United States," NBER Chapters, National Bureau of Economic Research, Inc, in: The Economic Effects of Aging in the United States and Japan, pages 153-194 National Bureau of Economic Research, Inc.
    44. Hurst, Erik & Stafford, Frank, 2004. "Home Is Where the Equity Is: Mortgage Refinancing and Household Consumption," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 36(6), pages 985-1014, December.
    45. Zoran Ivkovich & James Poterba & Scott Weisbenner, 2004. "Tax-Motivated Trading by Individual Investors," NBER Working Papers 10275, National Bureau of Economic Research, Inc.
    46. John R. Graham, 2000. "How Big Are the Tax Benefits of Debt?," Journal of Finance, American Finance Association, American Finance Association, vol. 55(5), pages 1901-1941, October.
    47. Bergstresser, Daniel & Poterba, James, 2004. "Asset allocation and asset location: household evidence from the survey of consumer finances," Journal of Public Economics, Elsevier, Elsevier, vol. 88(9-10), pages 1893-1915, August.
    48. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, American Finance Association, vol. 53(5), pages 1775-1798, October.
    49. Arthur B. Kennickell & Martha Starr-McCluer, 1994. "(Erratum) Changes in family finances from 1989 to 1992: evidence from the Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.), issue Nov, pages 990.
    50. Quigley, John M., 2002. "Homeowner Mobility and Mortgage Interest Rates: New Evidence from the 1990s," Berkeley Program on Housing and Urban Policy, Working Paper Series, Berkeley Program on Housing and Urban Policy qt9192767g, Berkeley Program on Housing and Urban Policy.
    51. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
    52. Garlappi, Lorenzo & Huang, Jennifer, 2006. "Are stocks desirable in tax-deferred accounts?," Journal of Public Economics, Elsevier, Elsevier, vol. 90(12), pages 2257-2283, December.
    53. James M. Poterba & John B. Shoven & Clemens Sialm, 2000. "Asset Location for Retirement Savers," NBER Working Papers 7991, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    1. Gary V. Engelhardt & Anil Kumar, 2007. "Employer matching and 401(k) saving: Evidence from the health and retirement study," NBER Chapters, National Bureau of Economic Research, Inc, in: Trans-Atlantic Public Economics Seminar (TAPES), Public Policy and Retirement, pages 1920-1943 National Bureau of Economic Research, Inc.
    2. Justine S. Hastings & Brigitte C. Madrian & William L. Skimmyhorn, 2013. "Financial Literacy, Financial Education, and Economic Outcomes," Annual Review of Economics, Annual Reviews, Annual Reviews, vol. 5(1), pages 347-373, 05.
    3. James J. Choi & David Laibson & Brigitte C. Madrian, 2005. "$100 Bills on the Sidewalk: Suboptimal Investment in 401(k) Plans," NBER Working Papers 11554, National Bureau of Economic Research, Inc.
    4. John Y. Campbell, 2006. "Household Finance," NBER Working Papers 12149, National Bureau of Economic Research, Inc.
    5. Poterba, James M. & Sinai, Todd, 2011. "Revenue Costs And Incentive Effects Of The Mortgage Interest Deduction For Owner-Occupied Housing," National Tax Journal, National Tax Association, vol. 64(2), pages 531-64, June.
    6. Karen E Dynan & Donald L Kohn, 2007. "The Rise in US Household Indebtedness: Causes and Consequences," RBA Annual Conference Volume, Reserve Bank of Australia, in: Christopher Kent & Jeremy Lawson (ed.), The Structure and Resilience of the Financial System Reserve Bank of Australia.
    7. D'Orlando, Fabio & Sanfilippo, Eleonora, 2010. "Behavioral foundations for the Keynesian consumption function," Journal of Economic Psychology, Elsevier, Elsevier, vol. 31(6), pages 1035-1046, December.
    8. Gene Amromin & Jennifer Huang & Clemens Sialm & Edward Zhong, 2010. "Complex mortgages," Working Paper Series, Federal Reserve Bank of Chicago WP-2010-17, Federal Reserve Bank of Chicago.
    9. Marekwica, Marcel & Schaefer, Alexander & Sebastian, Steffen, 2013. "Life cycle asset allocation in the presence of housing and tax-deferred investing," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(6), pages 1110-1125.
    10. Hyrum Smith & Michael Finke & Sandra Huston, 2012. "Financial Sophistication and Housing Leverage Among Older Households," Journal of Family and Economic Issues, Springer, Springer, vol. 33(3), pages 315-327, September.
    11. Geng Li & Paul A. Smith, 2009. "New evidence on 401(k) borrowing and household balance sheets," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2009-19, Board of Governors of the Federal Reserve System (U.S.).
    12. Anthony Webb, 2009. "Should You Carry A Mortgage Into Retirement," Issues in Brief ib2009-9-15, Center for Retirement Research, revised Jul 2009.
    13. Karen E. Dynan & Donald L. Kohn, 2007. "The rise in U.S. household indebtedness: causes and consequences," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2007-37, Board of Governors of the Federal Reserve System (U.S.).
    14. Geng Li & Paul A. Smith, 2008. "Borrowing from yourself: 401(k) loans and household balance sheets," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2008-42, Board of Governors of the Federal Reserve System (U.S.).

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:nbr:nberch:4363. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.