Harvard Business Study: Does Front-Loading Taxation Increase Savings?
There’s no evidence introducing a Roth 401(k) option decreases total employee 401(k) contribution rates, meaning the total amount of retirement funds bought via the 401(k) increases after the Roth is made available, according to a Harvard Business School study.
As viewers of Retirement News Today probably already know, there are two types of tax-favored retirement accounts. “Front-loaded” accounts, such as traditional IRAs and 401(k)s and “back-loaded” accounts, such as Roth IRAs. In front-loaded accounts, contributions are tax-deductible but withdrawals are taxed. In back-loaded accounts, contributions are not tax-deductible but accruals and withdrawals are tax-free.
According to Harvard Business School researchers “employee confusion about and neglect of the tax properties of Roth balances, along with partition dependence, prevent contribution rates from falling following a Roth introduction.”
The researchers suggest “governments may be able to increase after-tax private savings while holding the present value of taxes collected roughly constant by making savings non-deductible up front but tax exempt in retirement, rather than vice versa.”