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Does participating in a 401(k) raise your lifetime taxes?

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Author Info
Jagadeesh Gokhale
Laurence J. Kotlikoff
Todd Neumann

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Abstract

Contributing to 401(k)-type plans lowers current taxes, but does it lower lifetime taxes? If tax rates were independent of income and remained constant through time, the answer would be an unambiguous “yes.” But tax rates may be higher when retirement account withdrawals occur, either because one moves into higher marginal tax brackets or because the government raises tax rates. Moreover, reducing tax brackets when young in exchange for higher tax brackets when old renders mortgage deductions less valuable. Most importantly, shifting taxable income from youth to old age can substantially increase the share of Social Security benefits subject to federal income taxation. This paper studies the lifetime tax advantage gained from participating in 401(k) plans for stylized households. It finds that participation may increase lifetime taxes and reduce lifetime spending for low- and moderate-income households. In contrast, high-income households stand to derive significant lifetime spending gains from participating.

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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 0108.

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Length: 1-47
Date of creation: 2001
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Handle: RePEc:fip:fedcwp:0108

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Keywords: Income tax;

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  1. Jagadeesh Gokhale & Laurence J. Kotlikoff & Mark J. Warshawsky, 2001. "Life-Cycle Saving, Limits on Contributions to DC Pension Plans, and Lifetime Tax Benefits," NBER Working Papers 8170, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. James M. Poterba & Steven F. Venti & David A. Wise, 2001. "The Transition to Personal Accounts and Increasing Retirement Wealth: Macro and Micro Evidence," NBER Working Papers 8610, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  1. Jagadeesh Gokhale & Laurence J. Kotlikoff, 2001. "Who gets paid to save?," Working Paper 0114, Federal Reserve Bank of Cleveland. [Downloadable!]
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    • Jagadeesh Gokhale & Laurence J. Kotlikoff, 2003. "Who Gets Paid to Save?," NBER Chapters, in: Tax Policy and the Economy, Volume 17, pages 111-140 National Bureau of Economic Research, Inc. [Downloadable!]
  2. Erik Hurst & Paul Willen, 2004. "Social Security and Unsecured Debt," NBER Working Papers 10282, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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