New working paper: “The Relative Effects of Economic and Non-Economic Factors on Taxpayers’ Preferences Between Front-Loaded and Back-Loaded Retirement Savings Plans”

The Center for Retirement Research at Boston College has published a new working paper, “The Relative Effects of Economic and Non-Economic Factors on Taxpayers’ Preferences Between Front-Loaded and Back-Loaded Retirement Savings Plans,” by Andrew D. Cuccia, Marcus M. Doxey and Shane R. Stinson

Abstract

To understand the potential impact of tax incentives on individual retirement saving, we must understand how individuals make decisions about saving. We examine individual taxpayers’ choices between front-loaded (e.g., traditional) and back-loaded (e.g., Roth) defined contribution retirement savings plans, as well as their saving levels and investment style choices within a plan. To do so, we conduct a series of experiments that allow us to consider individual-specific expectations regarding the economic factors that normatively drive retirement saving decisions, as well as non-economic attitudes and preferences that may also impact these decisions. Overall, we find that participants generally prefer back-loaded retirement plans to front-loaded plans. We find mixed evidence regarding whether individuals appropriately weight expected tax rate changes in their plan choices, despite the fact that these tax rate changes are the primary factor driving the relative after-tax returns of front- and back-loaded plans. Conversely, we find evidence that plan attributes related to individuals’ non-economic attitudes and preferences consistently influence plan choice. Saving levels, while idiosyncratic and difficult to predict, are negatively associated with preference for back-loaded plans and may be influenced by tax-related contextual variables as well. Investment risk is also negatively associated with preferences for back-loaded plans.

The paper found that:

• Taxpayers prefer back-loaded plans over front-loaded plans.
• Individuals may not systematically rely on their beliefs regarding their relative tax rates when making plan choices. At least part of that failure is due to a lack of awareness and/or understanding.
• Individual saving levels and investment selections, while largely idiosyncratic and difficult to predict, are negatively associated with a preference for back-loaded plans and may be influenced by tax-related contextual variables as well.