Who Benefits from Tax-Preferred Savings Accounts?

Many countries use tax-preferred saving accounts to incentivize individuals to save for retirement. The two main forms of tax-preferred saving accounts – TEE and EET – tax savings at the contribution and withdrawal years respectively. Thus the relative returns of the two savings vehicles depend on the effective marginal tax rates in these two years, which in turn depend on earning dynamics. This paper estimates a model of earning dynamics on a Canadian longitudinal administrative database containing millions of individuals, allowing for substantial heterogeneity in the evolution of income across income groups. The model is then used, together with a tax and credit calculator, to predict how the returns of EET and TEE vary across these groups. The results suggest that TEE accounts yield in general higher returns, especially for low-income groups. Comparing optimal saving choices predicted by the model with observed saving choices in the data suggests that EET are over-chosen, especially in the province of Quebec. These results have important implications for “nudging†policies that are currently being implemented in Quebec, forcing employers to automatically enrol their employees in savings accounts similar to EET. These could yield very low returns for low-income individuals, which are known to be the most sensitive to nudging.