Optimal Savings with Taxable and Tax-Deferred Accounts

49 Pages Posted: 14 Sep 2004

See all articles by Valery Polkovnichenko

Valery Polkovnichenko

Board of Governors of the Federal Reserve System

Francisco Gomes

London Business School

Alexander Michaelides

Imperial College Business School; Centre for Economic Policy Research (CEPR)

Date Written: November 2006

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 Classification: G11

Suggested Citation

Polkovnichenko, Valery and Gomes, Francisco and Michaelides, Alexander, Optimal Savings with Taxable and Tax-Deferred Accounts (November 2006). Available at SSRN: https://ssrn.com/abstract=589241 or http://dx.doi.org/10.2139/ssrn.589241

Valery Polkovnichenko (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francisco Gomes

London Business School ( email )

Finance Department
Sussex Place - Regent's Park
London NW1 4SA
United Kingdom

HOME PAGE: http://sites.google.com/view/francisco-gomes/home

Alexander Michaelides

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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