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Saving For Retirement: Taxes Matter

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Author Info
James M. Poterba () (MIT)

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Abstract

To encourage individuals to save for retirement, federal tax policy provides various tax advantages for investments in self-directed accounts, such as traditional and Roth IRAs, and 401(k) plans. However, the differential tax treatment of these accounts and traditional taxable accounts can make it difficult for individuals to choose where to put their money and, once they have begun to accumulate assets, to evaluate how much they will have available in retirement. This Issue in Brief begins with a brief description of the types of accounts that individuals may consider for retirement saving. It then analyzes two separate issues that are relevant to different stages of the investment process: 1) where to invest; and 2) how to value existing investments. The first issue involves what type of account individuals should choose in order to maximize their after-tax rate of return, assuming that each account offers the same pre-tax return. The analysis of this fundamental saving decision considers both taxes that are paid "up-front" on contributions and taxes that are paid when funds are withdrawn. The second issue involves how to determine the after-tax value of existing assets in order to assess progress toward meeting a retirement saving target. Since, once the investments are made, "up-front" taxes are no longer relevant, this analysis looks only at taxes that are paid when funds are withdrawn or, in the case of taxable accounts, taxes that are due along the way.

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Paper provided by Center for Retirement Research in its series Issues in Brief with number ib17.

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Date of creation: 13 Aug 2004
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Handle: RePEc:crr:issbrf:ib17

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. Laurence J. Kotlikoff, Kent Smetters, and Jan Walliser, 2001. "The Coming Generational Storm," Computing in Economics and Finance 2001 276, Society for Computational Economics.
  2. James M. Poterba, 2004. "Valuing Assets In Retirement Saving Accounts," Working Papers, Center for Retirement Research at Boston College 2004-11, Center for Retirement Research. [Downloadable!]
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