Working Paper: NBER ID: w13763
Authors: Laurence J. Kotlikoff; Ben Marx; David Rapson
Abstract: Do regular 401(k) and IRA accounts offer greater tax benefits than Roth 401(k)s and Roth IRAs? This is a tough question. Regular 401(k)s and IRAs save taxes in the short term; Roth accounts save taxes in the long term. Regular 401(k)s and IRAs are vulnerable to future income tax hikes, but may benefit from a future switch to consumption taxation if the switch exempts withdrawals from income taxation. Roth accounts are exempt from future income tax hikes, but are exposed to future consumption taxation. For any given assumption about future tax policy, assessing the relative merits of the two types of saving vehicles requires very accurate calculations of taxes in each future year -- calculations that incorporate not just standard federal income tax provisions, but also the Savers Credit, the taxation of Social Security benefits, the Alternative Minimum Tax, and state income taxation. \n \nThis paper uses ESPlanner (Economic Security Planner) -- a financial planning software program co-developed by Kotlikoff -- to study the relative merits of regular and Roth retirement accounts. In providing its consumption smoothing recommendations, ESPlanner makes the highly detailed tax and Social Security benefit calculations needed to compare retirement account options. In particular, ESPlanner can determine how different retirement account options affect different households' living standards under different assumptions about future tax policy. \n \nOur main findings are these: Absent future tax changes, middle-income, single-parent households benefit slightly more from Roth accounts; other single and married households generally fare better with a regular 401(k). Future tax changes, however, can dramatically change this horse race. In the case of low- and middle-income households, Regular 401(k) accounts under-perform Roth accounts in terms of long-run living standards assuming income taxes will rise by 30 percent in retirement. But the Roth falls far short of the regular 401(k) if taxes in retirement are assessed on consumption rather than on income and the transition to consumption taxation exempts 401(k) withdrawals from income taxation.
Keywords: No keywords provided
JEL Codes: G0; H0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| future tax changes (H29) | benefits of Roth accounts for middle-income single-parent households (D14) |
| absent future tax changes (H29) | benefits of regular 401k accounts for other households (D14) |
| 30% increase in income taxes (H29) | underperformance of regular 401k accounts compared to Roth accounts (G23) |
| switch to consumption taxation (H29) | underperformance of Roth accounts compared to regular 401k accounts (H60) |
| tax policy expectations (H29) | choice between account types (M41) |