Does Front-Loading Taxation Increase Savings? Evidence from Roth 401(k) Introductions

by John Beshears, James J. Choi, David Laibson & Brigitte C. Madrian

Overview — Choosing the right retirement savings rate is complicated. In a study of whether governments can increase private savings by taxing savings up front rather than in retirement, the authors analyze the impact of a Roth option on savings plan contributions. Results suggest that governments could increase after-tax private savings while holding the present value of taxes collected roughly constant by making savings non-deductible up front but tax exempt in retirement, rather than vice versa.

Author Abstract

Can governments increase private savings by taxing savings up front instead of in retirement? Roth 401(k) contributions are not tax-deductible in the contribution year, but withdrawals in retirement are untaxed. The more common before-tax 401(k) contribution is tax-deductible in the contribution year, but both principal and investment earnings are taxed upon withdrawal. Using administrative data from 11 companies that added a Roth contribution option to their existing 401(k) plan between 2006 and 2010, we find no evidence that total 401(k) contribution rates differ between employees hired before versus after the Roth introduction, which means that the amount of retirement consumption being purchased by 401(k) contributions increases after the Roth introduction. A survey experiment suggests two behavioral factors play a role in the unresponsiveness of contribution rates to their tax treatment: (1) employee confusion about or neglect of the tax properties of Roth balances and (2) partition dependence.