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Tax-Deferred Savings and Early Retirement

  • Gaobo Pang

    ()

    (Dept. of Economics University of Maryland)

  • University of Maryland

This paper analyzes effects of tax-favored savings plans on savings and retirement decisions in a realistically specified life-cycle model. Individuals face mortality risk and stochastic earnings, allocate assets between conventional savings accounts (CSAs) and tax-deferred accounts (TDAs), make endogenous choice of labor supply and retirement, and make a separate decision on claiming Social Security. The simulations reveal that there is a functional division to some degree between CSAs and TDAs, with the former serving mainly for liquidity and the latter for retirement and bequests. There is tremendous heterogeneity. The tax incentives are generally effective in stimulating new savings for the middle and upper income groups. The higher rate of return on TDAs facilitates wealth accumulation, which consequently and perhaps unintentionally encourages early retirement. Impatient and low-income individuals tend to retire and claim Social Security early. They derive less benefit from TDAs since they face lower marginal tax rates and they have limited resources to take advantage of TDAs. For them, the income effect dominates and TDAs fail to induce new savings

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 31.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:31
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