Department of Finance, College of Business Administration, San Diego State University, 5500 Campanile Drive, San Diego, CA 92182-8236, USA (e-mail: [email protected])
This paper analytically solves a life-cycle model that compares traditional and Roth retirement accounts. It includes realistic features such as tax deductibility of contributions and taxation of withdrawals, tax bracket structure with deductions, taxation of Social Security benefits, and tax risk at retirement. With current taxes, choosing a traditional account over a Roth creates small welfare losses in only a few cases, largely for those with higher incomes and pensions who are subject to the taxation of Social Security benefits. We also investigate tax variability and find that diversified strategies offer only small risk reduction benefits in our illustrations.
(Online publication March 15 2012)
* The author would like to thank an anonymous referee, Nikhil Varaiya, and Stefano Gubellini for helpful comments.