How Does Tax Timing Affect Spending in Retirement?

Abstract

ABSTRACT This study investigates how the timing of taxes on retirement savings affects spending. Our findings are based on an experiment where participants spend funds from either a deferred-tax account, where taxes are paid upon withdrawal, or a currently taxed account, which represents after-tax savings withdrawn tax-free. We find that deferred-tax account holders consume savings faster than currently taxed account holders with equal after-tax spending power. Further, given equivalent nominal balances, deferred-tax and currently taxed account holders spend nominally equivalent amounts on goods, despite deferred-tax account holders needing to pay taxes on withdrawals. This finding suggests deferred-tax account holders under-adjust for taxes and, therefore, consume their wealth faster. These findings have important implications for financial advisors and tax policy makers. They also add to a growing body of research showing that tax timing affects individual decision making and that currently taxed accounts often encourage individuals to make better retirement planning decisions. Data Availability: Data are available from the third author, upon request. JEL Classifications: H24; K34.