A behavioural investigation of the substitution phenomenon between tax-sheltered savings plans

We provide behavioral insights into the economic substitution phenomenon among front-loaded and back-loaded tax-sheltered savings plans. We conduct three behavioral studies with adult Canadian participants to show experimentally that substitution can occur and to explain why substitution can occur. The first study shows that participants transfer savings from a front-loaded plan to a back-loaded plan when the latter becomes available, consistent with a substitution effect. The second study examines how participants trade-off two unique features of back-loaded and front-loaded savings plans. Our results indicate that participants favor the back-loaded tax feature and a variable contribution limit (offered in a front-loaded plan). As participants prefer one feature from each type of plan, this finding can help explain why substitution occurs. The third study provides participants a categorization task with various household budgeting items, including savings items. Results show that 68.1% of participants categorize multiple tax-sheltered savings plans in the same mental account, again consistent with a substitution effect under a budget constraint. As both tax-sheltered savings plans in Canada are used for different purposes, this finding shows that participants tend not to distinguish between the purpose of saving in each account, consistent with a substitution phenomenon.