Tax-Favored Savings Accounts: Who Gains? Who Loses?

Policy Reports | Taxes

No. 249
Thursday, January 31, 2002
by Jagadeesh Gokhale and Laurence J. Kotlikoff


  1. Jagadeesh Gokhale and Laurence J. Kotlikoff, "Does Participating in a 401(k) Raise Your Lifetime Taxes," National Bureau of Economic Research, NBER working paper No. 8341, June 2001.
  2. Larger Roth contributions leave the couple more liquidity-constrained. This means that the couple consumes less when young, and requires less life insurance for survivors to sustain that lower level of consumption. Consequently, when the young couple makes Roth contributions of $5,000, it spends less on insurance premiums and ends up saving somewhat more in non-tax-sheltered assets than would be the case had it contributed $2,000 each annually to a Roth. (See the Appendix for a fuller discussion of assumptions about taxing and saving hehavior.) This, in turn, means that the couple has more regular assets and has more regular asset income on which it must pay taxes. Hence, tax payments can be, and in this case are, higher with larger Roth contributions.
  3. The couple does pay the Medicare payroll tax but not the Social Security payroll tax.
  4. To be precise, to determine the amount of Social Security benefits that must be included in federal AGI, we first calculate provisional income--which is modified AGI (non-Social Security income including tax-exempt interest) plus half of the Social Security benefit. If provisional income exceeds the first threshold, X1, but not the second, X2, half of the excess over X1 or half of the Social Security benefit, whichever is smaller, is included in AGI. If provisional income exceeds X2, then the amount to be included equals the smaller of two items: A) 50 percent of benefits or $6,000, whichever is smaller, plus 85 percent of the excess of provisional income over X2, or B) 85 percent of benefits.
  5. James Poterba, Steven Venti and David Wise, "The Transition to Personal Accounts and Increasing Retirement Wealth: Macro and Micro Evidence," mimeo, Massachusetts Institute of Technology, May 2001.
  6. We assume this ceiling grows at 1 percent real per year.
  7. The new tax law specifies that the contribution limits will be indexed to inflation after 2007. However, we think it is likely that these limits will be adjusted over time for real wage growth. In modeling other changes in the new tax law we assume they continue after 2010 rather than revert back to their current values as formally stipulated in the new law.

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