The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings

52 Pages Posted: 14 Sep 2006 Last revised: 3 Sep 2010

See all articles by Jennifer C. Huang

Jennifer C. Huang

University of Texas at Austin - Department of Finance

Gene Amromin

Federal Reserve Bank of Chicago

Clemens Sialm

University of Texas at Austin - McCombs School of Business; National Bureau of Economic Research (NBER); AQR Capital Management, LLC

Multiple version iconThere are 2 versions of this paper

Date Written: August 2006

Abstract

We show that a significant number of households can perform a tax arbitrage by cutting back on their additional mortgage payments and increasing their contributions to tax-deferred accounts (TDA). Using data from the Survey of Consumer Finances, we show that about 38% of U.S. households that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making the wrong choice. For these households, reallocating their savings can yield a mean benefit of 11 to 17 cents per dollar, depending on the choice of investment assets in the TDA. In the aggregate, these mis-allocated savings are costing U.S. households as much as 1.5 billion dollars per year. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity considerations and that self-reported debt aversion and risk aversion variables explain to some extent the preference for paying off debt obligations early and hence the propensity to forgo our proposed tax arbitrage.

Suggested Citation

Huang, Jennifer Chunyan and Amromin, Gene and Sialm, Clemens, The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings (August 2006). NBER Working Paper No. w12502. Available at SSRN: https://ssrn.com/abstract=927386

Jennifer Chunyan Huang

University of Texas at Austin - Department of Finance ( email )

McCombs School of Business, B6600
Austin, TX 78712
United States
512-232-9375 (Phone)
512-471-5073 (Fax)

Gene Amromin

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
230 S. LaSalle
Chicago, IL 60604
United States
3123225368 (Phone)
3123226011 (Fax)

Clemens Sialm (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

HOME PAGE: http://faculty.mccombs.utexas.edu/Clemens.Sialm/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

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