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The Taxation of Retirement Saving: Choosing Between Front-Loaded and Back-Loaded Options

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  • Burman, Leonard E.
  • Gale, William G.
  • Weiner, David

Abstract

We examine retirement savers’ choices between front-and back-loaded tax incentives, such as traditional and Roth IRAs. With equal dollar contribution limits, back-loaded plans shelter more funds than front-loaded plans. This implies that Roth IRAs can be the preferred choice even for investors who expect their tax rates to fall in retirement. Empirically, we examine how marginal tax rates have varied between 1982 and 1995 for a sample of taxpayers and calculate both ex ante and ex post effective tax rates on front-loaded IRAs. The average effective tax rate on traditional IRA contributions made in 1982 and withdrawn in 1995 was -30 percent. Changes in tax law after 1982 reduced tax rates considerably. Holding tax law constant, the average effective tax rate on IRAs was about -11 percent. These results occur because the tax rate in retirement is lower for most people than the rate while working. In contrast, the effective tax rate on Roth IRAs is always zero. Despite the lower average effective tax rate on traditional IRAs, many taxpayers in the sample would have benefited from contributing to a Roth IRA instead of a traditional IRA, due to the difference in effective contribution limits.

Suggested Citation

  • Burman, Leonard E. & Gale, William G. & Weiner, David, 2001. "The Taxation of Retirement Saving: Choosing Between Front-Loaded and Back-Loaded Options," National Tax Journal, National Tax Association;National Tax Journal, vol. 54(3), pages 689-702, September.
    • Handle: RePEc:ntj:journl:v:54:y:2001:i:3:p:689-702
    DOI: 10.17310/ntj.2001.3.17
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    Cited by:

    1. Schwartz, Steven T. & Spires, Eric E. & Young, Richard A., 2015. "A teaching note on the tax benefits of retirement savings," Journal of Accounting Education, Elsevier, vol. 33(2), pages 164-181.
    2. James Poterba, 2004. "Valuing Assets in Retirement Saving Accounts," NBER Working Papers 10395, National Bureau of Economic Research, Inc.
    3. Horan, Stephen M. & Peterson, Jeffrey H., 2001. "A reexamination of tax-deductible IRAs, Roth IRAs, and 401(k) investments," Financial Services Review, Elsevier, vol. 10(1-4), pages 87-100.
    4. Frank Caliendo & W. Cris Lewis, 2004. "The Effect of the Current Ira Program on Federal Debt," Public Finance Review, , vol. 32(3), pages 331-351, May.
    5. M. Martin Boyer & Philippe d’Astous & Pierre-Carl Michaud, 2019. "Tax-Sheltered Retirement Accounts: Can Financial Education Improve Decisions?," Cahiers de recherche 1902, Chaire de recherche Industrielle Alliance sur les enjeux économiques des changements démographiques.
    6. Mariana Carrera & Heather Royer & Mark Stehr & Justin Sydnor, 2020. "The Structure of Health Incentives: Evidence from a Field Experiment," Management Science, INFORMS, vol. 66(5), pages 1890-1908, May.
    7. Rydqvist, Kristian & Schwartz, Steven T. & Spizman, Joshua D., 2014. "The tax benefit of income smoothing," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 78-88.
    8. Mattia Landoni & Stephen P. Zeldes, 2020. "Should the Government be Paying Investment Fees on $3 Trillion of Tax-Deferred Retirement Assets?," NBER Working Papers 26700, National Bureau of Economic Research, Inc.
    9. Gaobo Pang, "undated". "Tax-Deferred Savings and Early Retirement," Research Reports 3, Watson Wyatt Worldwide.
    10. Joshua Woodruff & William B. Haskell & Alejandro Toriello, 2016. "Optimized Financial Systems Helps Customers Meet Their Personal Finance Goals with Optimization," Interfaces, INFORMS, vol. 46(4), pages 345-359, August.
    11. Brown, David C. & Cederburg, Scott & O’Doherty, Michael S., 2017. "Tax uncertainty and retirement savings diversification," Journal of Financial Economics, Elsevier, vol. 126(3), pages 689-712.
    12. Saul W. Adelman & Mark L. Cross, 2010. "Comparing a Traditional IRA and a Roth IRA: Theory Versus Practice," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 13(2), pages 265-277, September.
    13. Richard L. Johnson, 2003. "Portfolio choice in tax-deferred and Roth-type savings accounts," Research Working Paper RWP 03-08, Federal Reserve Bank of Kansas City.

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