Does front-loading taxation increase savings? Evidence from Roth 401(k) introductions

Area of Science:

• Behavioral Economics
• Public Finance
• Retirement Savings

Background:

• Traditional 401(k) plans offer tax-deductible contributions, with withdrawals taxed in retirement.
• Roth 401(k) plans feature after-tax contributions, but qualified withdrawals are untaxed.
• The study examines the impact of introducing Roth 401(k) options on private savings behavior.

Purpose of the Study:

• To investigate whether governments can boost private savings through upfront taxation of retirement savings (Roth 401(k)s).
• To analyze the effect of Roth 401(k) introduction on employee contribution rates and savings behavior.
• To explore behavioral explanations for observed savings patterns.

Main Methods:

• Analysis of administrative data from eleven companies that introduced Roth 401(k) options between 2006 and 2010.
• Comparison of contribution rates for employees hired before and after Roth option introduction.
• A survey experiment to test behavioral hypotheses.

Main Results:

• No significant difference in total 401(k) contribution rates was found after the introduction of Roth options.
• This implies a decrease in take-home pay and an increase in retirement consumption purchased via 401(k)s.
• Neoclassical economic explanations were insufficient to explain the null findings.

Conclusions:

• Employee confusion regarding Roth tax properties and partition dependence are likely behavioral drivers.
• Government incentives for retirement savings may be less effective than anticipated due to behavioral factors.
• Further research into behavioral economics is needed to understand and influence retirement savings decisions.