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Roth versus traditional accounts in a life-cycle model with tax risk*

  • MARIE-EVE LACHANCE (a1)
Abstract
Abstract

This paper analytically solves a life-cycle model that compares traditional and Roth retirement accounts. It includes realistic features such as tax deductibility of contributions and taxation of withdrawals, tax bracket structure with deductions, taxation of Social Security benefits, and tax risk at retirement. With current taxes, choosing a traditional account over a Roth creates small welfare losses in only a few cases, largely for those with higher incomes and pensions who are subject to the taxation of Social Security benefits. We also investigate tax variability and find that diversified strategies offer only small risk reduction benefits in our illustrations.

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The author would like to thank an anonymous referee, Nikhil Varaiya, and Stefano Gubellini for helpful comments.

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This list contains references from the content that can be linked to their source. For a full set of references and notes please see the PDF or HTML where available.

L.E. Burman , W.G. Gale and D. Weiner (2001) The taxation of retirement saving: choosing between front-loaded and back-loaded options. National Tax Journal, 54(3): 689702.

J. Cocco , F. Gomes and P. Maenhout (2005) Consumption and portfolio choice over the life cycle. Review of Financial Studies, 18(2): 491533.

F. Gomes , A. Michaelides and V. Polkovnichenko (2009) Optimal savings with taxable and tax-deferred accounts. Review of Economic Dynamics, 12: 718735.

H. He and H.F. Pages (1993) Labor income, borrowing constraints, and equilibrium asset prices. Economic Theory, 3: 663696.

D.I. Laibson , A. Repetto and J. Tobachman (1998) Self-control and saving for retirement. Brookings Papers on Economic Activity, 91172.

D.A. Love (2007) What can the life-cycle model tell us about 401(k) contributions and participation? Journal of Pension Economics and Finance, 6(2): 14731492.

M.E. Yaari (1965) Uncertain lifetime, life insurance, and the theory of the consumer. Review of Economic Studies, 32(3): 137150.

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Journal of Pension Economics & Finance
  • ISSN: 1474-7472
  • EISSN: 1475-3022
  • URL: /core/journals/journal-of-pension-economics-and-finance
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