UM19-12: How Would 401(k) Rothification Influence Consumption, Saving, and Social Security Claiming Behavior?
The US incentivizes retirement saving in 401(k) and similar retirement accounts by permitting workers to defer taxes on contributions; taxes are then levied only when retirees withdraw their funds. Yet the Treasury foregoes over $100B/year due to tax-deferred contributions to retirement plans, and some policymakers have favored moving the tax revenue back in time to reduce government budget shortfalls. The idea of eliminating or capping tax-qualified retirement plan contributions – termed ‘Rothification’ – was floated during the 2017 tax reform debate. These proposals were withdrawn yet the topic is certain to be revisited given the amount of revenue involved. Our project will use a dynamic life cycle model to show how taxing 401(k) contributions rather than payouts will alter household saving, investment, and Social Security claiming patterns. We will also assess how these changes differ for low-earning versus higher-paid workers, and we will explore whether these behaviors would differ in a persistent low interest rate environment.