Government's Costs for Retirement Accounts

Abstract

This paper analyzes the government’s costs for both Traditional and Roth retirement accounts. It shows that for both accounts, the costs for government are not equal to the benefits for savers. The costs for government compound at the government’s low cost of borrowing. But for savers benefits compound at the investment’s rate of return.

For both accounts, governments face the cost of permanently sheltered profits from tax. That same factor is a benefit for savers. For Traditional accounts, governments face a cost (benefit) from withdrawals at tax rates lower (higher) than at contribution. The reverse for savers. Traditional accounts give governments a benefit from leveraged investing. Essentially the government borrows at low Treasury debt rates and gives it to savers to invest (on the government’s behalf) earning larger portfolio returns.

In many likely scenarios Traditional accounts are cheaper. But the opposite is also true. It depends on the relationship between the Traditional account’s benefit from leverage vs. its cost from lower withdrawal tax rates. Government policy changes should protect the third factor’s benefit and delete the second factor’s cost.

Keywords: Retirement Accounts, Roth, Traditional, 401(K), Tax Expenditures, Benefits

JEL Classification: D14, J26, H24, K34