On the Taxation of Private Retirement Wealth

Abstract

Private retirement plans have become an increasingly important component of household wealth in the United States, with nearly two-thirds of Americans having access to employer-sponsored defined contribution plans. These plans have significant tax advantages, as both employee and employer contributions are tax-exempt, while the returns remain untaxed until their withdrawal during retirement. We develop a quantitative life-cycle model that incorporates both private and public pension systems, the life-cycle profile of homeownership, as well as a detailed tax-transfer system. Our model is able to replicate key empirical regularities, such as the observed distribution of private retirement wealth by age and income and the age and income dependence of pickup rates. When we eliminate the tax advantages of private pensions, we find that both the employee and employer tax-free contributions play an important role. Moreover, the reform that eliminates all tax advantages of private pensions leads to a considerable decline in both pension and total wealth, a wider tax base that allows the government to reduce taxation, generating substantial intergenerational redistribution towards current generations and small effects on within-cohort inequality.