Who gets paid to save?

Thanks to recent changes in the tax law, people can contribute more to their tax-deductible and non-tax-deductible savings plans, including 401(k) and Roth IRAs. But should they? The myriad interacting provisions of the tax code make it difficult to predict who will gain from government savings incentives and by how much. This study examines how new legislation affects the lifetime tax gains (or losses) of low, middle, and high lifetime earners if they contribute the maximum to 401(k) accounts, traditional IRA accounts, and Roth IRA accounts. The study finds that the new legislation changes little for low- and middle-income earners, who paid higher lifetime taxes under the old tax law if they participated fully in tax-deferred plans and would still do so under the new law. If a new tax credit created by the legislation were extended and indexed to inflation, low earners would break even, but middle earners would still lose. In contrast, participating in a Roth IRA provides a guaranteed and nontrivial lifetime tax saving; however, one need not contribute the maximum to receive the full benefit.Saving and investment

The equity of social services provided to children and senior citizens

A consideration of the degree of equity in the U.S. government's treatment of children vis-a-vis adults, particularly the elderly. The authors show that given current policy, today's and tomorrow's children could end up paying as much as 70 percent of their lifetime income to the government, whereas the current elderly will pay only about 25 percent on average.Social service

Life-cycle saving, limits on contributions to DC pension plans, and lifetime tax benefits

This paper analyzes questions related to defined contribution (DC) plans. For what types of households are statutory contribution limits likely to bind? How large is the lifetime tax benefit from participating in a DC plan and how does it vary with lifetime income? The authors find that contribution limits bind for households that begin their plan participation late in life or wish to retire early, single-earner households, those who are not borrowing-constrained, those with rapid rates of real wage growth, and those with high levels of earnings regardless of age. Setting contribution rates at the average maximum level allowed by employers and assuming a 4% real return on assets, the lifetime benefit rises from 2% of lifetime consumption for households earning $25,000 per year, to 9.8$300,000 per year. Contribution ceilings limit the benefit for high earners and are sensitive to the assumed rate of return.Saving and investment ; Retirement

Comparing the Economic and Conventional Approaches to Financial Planning

The conventional approach to retirement and life insurance planning, which is used throughout the financial planning industry, differs markedly from the economic approach. The conventional approach asks households to specify how much they want to spend before retirement, after retirement, and in the event of an untimely death of the head or spouse. It then determines the amounts of saving and life insurance needed to achieve these targets. The economic approach is based on the life-cycle model of saving. Its goal is to smooth households' living standards over their life cycles and to ensure comparable living standards for potential survivors. In the economic approach, spending targets are endogenous. They are derived by calculating the most the household can afford to consume in the present given that it wants to preserve that living standard in the future. Although spending targets under the conventional approach can be adjusted in an iterative process to approximate those derived under the economic approach, there are practical limits to doing so. This is particularly the case for households experiencing changing demographics or facing borrowing constraints. This paper illustrates the different saving and insurance recommendations provided by economic financial planning software and the practical application of traditional financial planning software. The two software programs are Economic Security Planner (ESPlanner), developed by Economic Security Planning, Inc., and Quicken Financial Planner (QFP), developed by Intuit. Each program is run on 24 cases, 20 of which are stylized and 4 of which are actual households. The two software programs recommend dramatically different levels of saving or life insurance in each of the 24 cases. The different saving recommendations primarily reflect ESPlanner's adjustment for household demographics and borrowing constraints. The different life insurance recommendations reflect these same factors as well as ESPlanner's accounting for contingent household plans and for Social Security's survivor benefits. The less detailed tax and Social Security retirement benefit calculations used in our implementation of QFP also explain some of the differences between the two programs.

Generational accounting: a new approach for understanding the effects of fiscal policy on saving

An application of generational accounting to fiscal policies that feature intergenerational redistribution. The authors consider different policies, only some of which show up as a change in the deficit, and explore their impact on the net national saving rate.Deficit financing ; Fiscal policy ; Saving and investment

Generational accounts: a meaningful alternative to deficit accounting

A presentation of a set of generational accounts that can be used as an alternative to the federal budget deficit in assessing intergenerational policy, concluding that the fiscal burdens on future generations will be significantly larger than those on existing generations if current tax policy remains unchanged.Deficit financing ; Fiscal policy

Understanding the postwar decline in United States saving: a cohort analysis

An analysis of the postwar decline in U.S. national saving that decomposes changes in the net national saving rate into those due to changes in cohort-specific consumption propensities, the intergenerational distribution of resources, the rate of government spending, and demographics. ; A review and expansion of Calomiris, Kahn, and Longhofer's (1994) cultural affinity theory of discrimination in the residential mortgage market, which is based on the idea that lenders find it easier or less costly to evaluate the creditworthiness of applicants with whom they have a common experiential background.Saving and investment

Does participating in a 401(k) raise your lifetime taxes?

Contributing to 401(k)-type plans lowers current taxes, but does it lower lifetime taxes? If tax rates were independent of income and remained constant through time, the answer would be an unambiguous “yes.” But tax rates may be higher when retirement account withdrawals occur, either because one moves into higher marginal tax brackets or because the government raises tax rates. Moreover, reducing tax brackets when young in exchange for higher tax brackets when old renders mortgage deductions less valuable. Most importantly, shifting taxable income from youth to old age can substantially increase the share of Social Security benefits subject to federal income taxation. This paper studies the lifetime tax advantage gained from participating in 401(k) plans for stylized households. It finds that participation may increase lifetime taxes and reduce lifetime spending for low- and moderate-income households. In contrast, high-income households stand to derive significant lifetime spending gains from participating.Income tax