The tradeoff between mortgage prepayments and tax-deferred retirement savings

Many households face the tradeoff between paying an extra dollar off the remaining mortgage on their house and saving that extra dollar in tax-deferred accounts (TDAs) used for retirement. We show that, under certain conditions, it becomes a tax arbitrage to reduce mortgage prepayments and to increase TDA contributions because of the tax deductibility of mortgage interest and tax-exemption of qualified retirement savings. Using data from the Survey of Consumer Finances, we document that a significant number of households that are accelerating their mortgage payments instead of saving in TDAs forgo a profitable tax arbitrage opportunity. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity or other financial constraints. Rather, the observed behavior can be attributed to a certain extent to the reluctance of many households to participate in financial markets as either lenders or borrowers.     

WHY HAVE U.S. HOUSEHOLDS INCREASINGLY RELIED ON MUTUAL FUNDS TO OWN EQUITY?

U.S. households have increasingly used mutual funds to own equity outside of retirement accounts owing to two developments. The first is a decline in equity mutual fund loads, which are negatively correlated with stock ownership rates, which have doubled owing to greater ownership through mutual funds. The second is improved confidence in future family finances. Both effects are consistent with recent models of equity participation, in which lower asset transfer costs and lower income risk induce equity investing by middle‐income households, who—in practice and owing to diversification considerations—are more likely to indirectly hold stocks through mutual funds.     

EFFECTS OF STOCK MARKET FLUCTUATIONS ON THE ADEQUACY OF RETIREMENT WEALTH ACCUMULATION

This paper examines the relation between fluctuations in the aggregate value of equities and the adequacy of households’ saving for retirement. Using more recent data than most studies on this topic, we find that many and perhaps most households appear to be saving adequate amounts for retirement, and that there is almost no link between aggregate equity values and the adequacy of retirement saving. A simulated 40 percent decline in stocks has little effect on the adequacy of saving. The substantial growth in equity values and ownership in the 1980s and 1990s did not lead to a surge in the adequacy of retirement saving provisions. The results occur because equity holdings are concentrated among households with significant amounts of other wealth.     

TAXES,INCOME, AND RETIREMENT SAVINGS: DIFFERENCES BY PERMANENT AND TRANSITORY INCOME

This article examines the determinants of and benefits from saving for retirement in tax‐preferred accounts by permanent and transitory income levels. We find that higher incomes (both permanent and transitory) are associated with a greater probability to contribute and larger contributions. We also find that tax benefits for retirement savings increase strongly with income, although the increase is slightly smaller when taxpayers are ranked by their permanent (rather than current) income. In addition, we find that a large portion of the benefits from the Saver's Credit go to taxpayers who would not be eligible based on their permanent income. Finally, we find that recent tax changes (including the introduction of the Saver's Credit) significantly increased contributions among low‐income households, although the effect was centered among those with only transitorily low income. (JEL H24, H31, E21)     

RETIREMENT WEALTH AND LIFETIME EARNINGS*

This article argues that a satisfactory theory of wealth inequality should account not only for the marginal distribution of wealth, but also for the joint distribution of wealth and earnings. The article describes the joint distribution of retirement wealth and lifetime earnings in the Panel Study of Income Dynamics. It then evaluates the ability of a stochastic life‐cycle model to account for key features of this distribution. The life‐cycle model fails to account for three key features of the data. (1) The correlation between lifetime earnings and retirement wealth is too high. (2) The wealth gaps between earnings rich and earnings poor households are too large. (3) Wealth inequality among households with similar lifetime earnings is too small. Models in which households differ in rates of return or time preferences account much better for the joint distribution of retirement wealth and lifetime earnings.     

Estimates of Capital Stock and Capital/Output Coefficients by Industries: Korea (1953–86)

This paper constructs a polynomial-benchmark model to estimate gross and net capital stocks by explicity estimating implicit retirement rates and depreciation rates. The model is applied to Korean data (1953–86) where such data as national wealth survey, national income accounts and industrial census are available. There alternative series of capital stock estimates are generated and compared with previous estimates. It is shown that the use of a pure perpetual-inventory model or a benchmark-year method alone may introduce a significant bias in the measurement of capital stocks for developing economies.     

An empirical analysis of household savings in France 1984–1998

In this paper we analyse the saving behaviour of French households by cohort and by age. We exploit two data sets: the Household Budget Surveys (HBS) allow us to define saving as residual of income minus consumption, while the Financial Assets Surveys (FAS) give us saving as changes in wealth. We make use of both financial assets surveys, gross them up using national accounts, and distinguish between “active” and “passive” saving.In France, tax policies appear to be one of the main factors that explain the recent evolution of household saving rates. The complex tax treatment of savings and capital income as well as the way in which households perceive the future of the French retirement pension system (5) also help to explain the composition of active and passive saving.     

Individual Characteristics and the Disposition Effect: The Opposing Effects of Confidence and Self-Regard

We conduct two experiments to examine potential causes of the disposition effect. In Experiment 1, we rule out beliefs in mean reversion as a cause of the disposition effect. Although a belief in the mean reversion of stock prices should be independent of whether an investor owns or only follows the stock, we show only investors who own the stock behave as though prices will reverse. In Experiment 2, participants buy and sell securities over multiple periods. We find that self-regard and investing confidence (two types of self-esteem) have opposing influences on investors’ tendency to hold losing investments. Investors with lower self-regard hold losing investments longer than those with higher self-regard, and investors with higher confidence hold losing investments longer than those with lower confidence. We focus on investors’ tendency to hold losing stocks too long because prior research suggests the gain versus loss sides of the disposition effect are driven by different biases.     

Saving and the intra-household distribution of income: an empirical investigation

This paper presents an empirical analysis of the relationship between household saving and the distribution of income within the household. Various theoretical reasons why the level of saving might depend on the latter are given. Some of these can be rationalized within the usual “unitary” model of household decision but others recognize explicitly that different members of the household may have different preferences about how much to save.Particular attention is paid to saving for retirement since the facts that wives are, on average, younger than their husbands and women have longer life expectancies means that wives typically anticipate a longer retirement period than their husbands. Thus wives may prefer to save more for retirement than their husbands.The empirical analysis uses a sample of Canadian households from five Family Expenditure Surveys. These surveys include measures of financial saving as well saving in retirement accounts. After accounting for many of the other influences on saving (for example: age, household composition, occupation and education levels but not household income) we find some effects of the intra-household distribution of income on savings rates. The parameter estimates suggest that the household saving rate decreases with the share of the wife in household income.     

Financial literacy and retirement planning: evidence from China

We study the relationship between financial literacy and retirement planning in China. We find that higher scores on the financial literacy questions are associated not only with a higher probability of retirement planning, but also a higher propensity to actively use financial markets for retirement preparation. These relationships are robust to taking into account the endogeneity of financial literacy.     

Saving Accounts versus Stocks and Bonds in Household Portfolio Allocation

We study the structure of household portfolios of financial wealth by analyzing both the determinants of total financial wealth and the choice between risky (stocks and bonds) and riskfree assets (saving accounts). The econometric specification is a generalized trivariate Tobit model, estimated on a cross section of 3,077 households in the Netherlands in 1988. We account for endogeneity of financial wealth and for selectivity due to nonreporting. Results show that the level of financial wealth and the marginal tax rate are major determinants of the allocation between riskfree and risky assets.     

Cognitive abilities and portfolio choice

We study the relation between cognitive abilities and stockholding using the recent Survey of Health, Ageing and Retirement in Europe (SHARE), which has detailed data on wealth and portfolio composition of individuals aged 50+ in 11 European countries and three indicators of cognitive abilities: mathematical, verbal fluency, and recall skills. We find that the propensity to invest in stocks is strongly associated with cognitive abilities, for both direct stock market participation and indirect participation through mutual funds and retirement accounts. Since the decision to invest in less information-intensive assets (such as bonds) is less strongly related to cognitive abilities, we conclude that the association between cognitive abilities and stockholding is driven by information constraints, rather than by features of preferences or psychological traits.     

Social security and unsecured debt

In this paper, we use a calibrated life-cycle model to explore quantitatively ways of reducing the burden of social security in a world populated by both optimizing and rule-of-thumb consumers. Social security contributions force young households with upward-sloping income profiles to save a sizeable portion of their income for retirement, when their optimal consumption plan would likely have them either saving little or borrowing. We first use household data to document that young households have accumulated social security contributions that are large relative to debt holdings. Then, using a calibrated life-cycle model, we show that both allowing households to use social security wealth to pay off their debt and exempting young households from social security contributions (but in both cases requiring higher contributions later) mitigate many of the inefficiencies of social security from the perspective of life-cycle financial planning. Specifically, in our preferred experiment, which exempts households whose heads are under 30 from making social security contributions, we find that certainty-equivalent consumption increases by 3.4% for optimizing households and by 3.3% for rule-of-thumb households.     

Consumption growth,saving and retirement in the U.K.

This paper examines age profiles of consumption and income from 25 successive years of the U.K. Family Expenditure Survey, looking in particular at households as they retire. We break down income and expenditure data for different cohorts and assess how they change over the life-cycle and around the time of their retirement. We then compare periods of unemployment and retirement and separate expenditures into some broad categories. Using stochastic Euler conditions we assess the anticipated impact of retirement against that of unemployment. It emerges that although income typically falls by more at unemployment than retirement the reverse is true for expenditure. Since the Euler equation results point to each having similar anticipated effects on consumption, the only way in which the life-cycle hypothesis (LCH) could be reconciled with this would be with the arrival of new information at the time of retirement.     

ANNUITIZED ASSET ADEQUACY IN JAPAN: THE DEMAND FOR INDIVIDUAL PENSIONS

In this paper, I analyze the impact of social security wealth, retirement payments, and living expenses during retirement on people's retirement savings in general, and on their individual pension holdings in particular, using micro data from a 1996 Japanese household survey. I confirm a replacement effect of social security on saving for all types of households and on individual pensions for self‐employed households only. This suggests that the social security assets of self‐employed households are less than their optimal level of annuitized assets and that they would increase their demand for individual pensions if social security benefits were to be reduced.     

Is there a retirement consumption puzzle in Japan? Evidence from a household panel dataset spanning several years

Using a unique long-run panel of Japanese households, this paper examines the changes in consumption at retirement (‘the retirement-consumption puzzle’). Our analysis shows that households’ expenditure does decline after the retirement of the household head and that changes in household composition at retirement cannot fully account for this decline. Changes in life-style/preferences after retirement also do not appear to explain a salient feature of the expenditure decline, namely, the strong correlation between the magnitudes of the expenditure decline and the income decline upon retirement. On the other hand, our finding that the expenditure decline is larger for households with smaller savings and/or that experienced a large unexpected income decline is broadly consistent with the standard LC/PIH augmented with unexpected shocks, while it does not rule out the possibility that there is a relatively small subset of households that are myopic and lack sufficient saving discipline.     

A METHOD FOR IMPROVED CAPITAL MEASUREMENT BY COMBINING ACCOUNTS AND FIRM INVESTMENT DATA

We propose a new method for estimating capital stocks at the firm level by combining business accounts information and investment data. The method also produces capital estimates at the sector or industry level by summing individual firms' capital stocks and appropriately inflating this sum to account for firms not included in the data set. Our approach has two major advantages compared with the much used Perpetual Inventory Method (PIM). First, long investment series are not necessary. Second, sector capital estimates are automatically adjusted for changes in the capital stock because of entry and exit of firms. While capital growth rates in Norwegian manufacturing were only 1 percent on average during 1993–2004 according to national accounts figures, our method yields much higher growth rates of 5.5 percent on average.     

Intergenerational policy and the measurement of tax incidence

We evaluate the ability of generational accounting to assess the potential welfare implications of policy reforms. In an intergenerational context policy reforms usually have redistributive, efficiency, and general equilibrium implications. Our analysis shows that when the policy reform implies changes in economic efficiency, generational accounts can be misleading not only about the magnitude of welfare changes, but also about the identity of who wins and who losses. In contrast, the generational accounts correctly identify welfare changes when the policy reform has only a pure intergenerational redistribution component. We illustrate and quantify this issue in the context of widely considered policy reforms (substitution of consumption for labor taxation, and the increase of retirement age) and in a more general context of optimal policy.     

Dividend taxation and household dividend portfolio decisions: evidence from the U.S. Jobs and Growth Tax Relief Reconciliation Act of 2003

This study examines the dividend clientele hypothesis by focusing on the preferential tax treatment of qualified dividends provided by the 2003 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) in the United States. Using the Public Use Tax File data, the author finds that the ratios of dividends to long-term capital gains before the 2003 tax act significantly declined with household tax rate differentials between dividends and long-term capital gains, but such a negative tax effect on the ratios disappears afterwards. This seemingly tax-inefficient composition of dividends and long-term capital gains after the tax act arises from households’ ability to reduce their tax burdens on stocks by exploiting the new preferential tax treatments on qualified dividends under JGTRRA. That is, households in the upper tax bracket hold significantly greater shares of qualified dividends relative to ordinary dividends after the tax act.     

GROSS AND NET CAPITAL, AND THE FORM OF THE SURVIVAL FUNCTION: THEORY AND SOME NORWEGIAN EVIDENCE

In this paper we discuss the empirical measurement of capital stocks derived from data on gross investment. Two capital concepts are involved: gross capital-representing the capital's capacity dimension-and net capital–representing its wealth dimension. A brief summary of their components is presented.
The data base consists of long series of Norwegian national accounts data for gross investment at a disaggregated level of sector classification and for 1–3 capital categories within each sector. Survival functions, representing the process of retirement and decline in efficiency of capital units over time, with different curvature (concave, convex) and non-zero interest rates for the discounting of future capital service flows are considered. The effects of these parameters on the calculated gross and net capital stocks in the years 1956–82 as well as on the implied replacement and depreciation rates and rates of return are discussed.