Optimal Savings with Taxable and Tax-Deferred Accounts

Abstract:     
We use a calibrated life-cycle model with earnings risk and liquidity constraints to study the role of tax-deferred retirement accounts (TDAs) in life cycle savings behavior. We find that they promote higher wealth accumulation but not higher net savings. Consumption increases mostly during retirement, as desired, but the effect is largest for those households with higher savings rates already. The cost of maintaining a constant TDA contribution rate is small, but the optimal rate differs substantially across households: a "one-size-fits-all" rule does not exist. Fully exhausting employer-matching contributions, as typically recommended by financial advisors, is highly suboptimal for most households, which is consistent with the data. Moreover, employer-matching schemes actually discourage savings as the corresponding income effect dominates.

Keywords: Portfolio Choice, Tax-Deferred Accounts, Retirement Savings, Liquidity Constraints, Uninsurable Labor Income Risk

JEL Classifications: G11

Working Paper Series