The Effects of Income Tax Timing on Retirement Investment Decisions

Abstract

ABSTRACTIn an online experiment, the immediate (Roth) versus deferred taxation of retirement income affects taxpayers' investment decisions such that tax-deferred plan investors under-adjust for future tax burdens and overestimate their future wealth compared to Roth investors. When presented with a specific after-tax monetary goal, Roth account holders invest more in higher-risk, higher-return assets than tax-deferred account holders. We investigate four aspects of this investment context that could alleviate these differences: (1) implementing a “do-your-best” goal, (2) reframing specific goals in pre-tax dollars, (3) explicitly prompting investors to estimate future tax burdens, and (4) providing performance feedback. These interventions reduce differences between Roth and tax-deferred investor behaviors, but do not entirely close the gap on their own. In combination, reframing goals and prompting future tax estimations encourage tax-deferred account holders to invest in risky assets to the same degree as Roth investors only when paired with performance feedback.