This chapter examines whether countries can improve the design of financial incentives to promote savings for retirement. After describing how countries currently design financial incentives, it assesses the overall tax advantage that these incentives provide to individuals, how these incentives affect the way individuals save for retirement, and the fiscal cost these incentives represent to governments. The chapter also compares different approaches to designing financial incentives, based on their inherent characteristics within a common framework, to assess the various implications for individuals and governments. It concludes with policy guidelines to help countries improve the design of their financial incentives to promote savings for retirement.
OECD Pensions Outlook 2018
Chapter 2. Can countries improve the design of financial incentives to promote savings for retirement?
Abstract
Governments have long used financial incentives to promote savings for retirement. Financial incentives encourage participation in retirement savings plans and boost overall retirement income by making private savings, typically a complement to public pension systems, more attractive and inclusive. Historically, tax incentives have been the dominant form of these incentives, providing favourable income tax treatment to savings for retirement relative to other types of savings. More recently, new types of financial incentives, not directly linked to the income tax system, have become more frequent. These non-tax incentives include matching contributions and fixed nominal subsidies paid into the pension account of eligible individuals.
These financial incentives represent a fiscal cost for governments. Therefore, it is important to evaluate whether they are effective tools for encouraging people to save for retirement, taking into account the different needs across the population.
The goal of this chapter is to discuss whether countries can improve the design of financial incentives to promote savings for retirement. It presents policy guidelines that can be used for that purpose. It provides a summary of four years of analysis conducted by the OECD under the project on Financial Incentives and Retirement Savings. It uses two measures to compare the outcomes of different designs of tax and non-tax incentives for individuals and governments.1 The analysis focuses on funded and private pension arrangements in 42 OECD and selected non-OECD countries.
All of the countries analysed offer financial incentives to promote savings for retirement. These incentives are found to be effective tools to promote savings for retirement as they are shown to provide a meaningful tax advantage for contributions to a retirement plan relative to other savings vehicles. As a result of this tax advantage, people react by increasing their participation in, and contributions to, retirement plans. The evidence reviewed indicates that low-income earners are likely to be more sensitive to non-tax incentives than to tax incentives. Although the total fiscal cost of financial incentives varies greatly across countries, it is projected to remain in the low single digits of GDP for most. While different designs of financial incentives may be economically equivalent in certain circumstances, the way individuals perceive them may affect their behaviour and influence the amount saved in retirement plans. Countries can, therefore, improve the design of financial incentives by considering policy guidelines based on the analysis and experience to date.
The chapter is structured as follows. Section 2.1 briefly describes how different countries have designed their financial incentives. Section 2.2 assesses the overall tax advantage that these incentives provide when individuals save for retirement in comparison to a benchmark savings instrument. Section 2.3 examines evidence of the effectiveness of financial incentives at increasing retirement savings, while Section 2.4 assesses their fiscal cost. Section 2.5 compares the pros and cons of different approaches to designing financial incentives. Section 2.6 presents conclusions and provides policy guidelines to help countries improve the design of their financial incentives with a view to promoting savings for retirement.
2.1. How do countries design financial incentives to promote savings for retirement?
Countries use two primary types of financial incentive to encourage individuals to save for retirement, tax incentives and non-tax incentives. Traditional forms of savings are taxed the same way as other income and earnings: contributions are paid from after-tax earnings; the investment income generated is taxed; and withdrawals following retirement age are exempted from taxation. This is generally referred to as the “Taxed-Taxed-Exempt” or “TTE” tax regime. Tax incentives for retirement savings arise from deviating from this benchmark. Non-tax incentives include matching contributions and fixed nominal subsidies. These are payments made by the government or employers directly into the pension account of eligible individuals.2
To establish the tax treatment of retirement savings, it is necessary to know how contributions, returns on investment and withdrawals are taxed. A preferential tax treatment on those three flows can take the form of tax deductions, tax exemptions, tax credits or tax rate relief. Tax deductions and tax exemptions reduce an individual’s taxable income. The value of the reduction in tax liability associated with the deduction or exemption depends on an individual’s marginal tax rate. For example, contributions may be deducted from taxable income (fully or partially) before calculating the tax due, while returns on investment may be excluded from the tax base. By contrast, tax credits directly reduce tax liability. A tax credit may be calculated as a proportion of the contributions paid into a retirement savings plan or can be a fixed nominal amount. Tax credits are classified as “non-refundable” when the value of the credit cannot exceed the tax liability. Finally, tax rate reliefs reduce the tax rate applied on the income flow. For all these tax treatments, caps can be introduced to limit tax relief.
The most common tax treatment of retirement savings exempts contributions and returns on investment from taxation while taxing pension benefits and withdrawals as income. Figure 2.1 classifies countries according to the tax treatment of contributions, returns on investment and withdrawals for the main retirement savings plan. Half of OECD countries use a variant of the “Exempt-Exempt-Taxed” (“EET”) tax regime. However, a wide range of other tax regimes can be found as well, from the “EEE” regime where contributions, returns on investment and pension income are all tax exempt, to regimes where two of three flows are taxed.3
Figure 2.1. Tax treatment of retirement savings, 2018
Notes: Main pension plan in each country. “E” stands for “exempt” and “T” for “taxed”. Countries offering tax credits on contributions are considered as taxing contributions, as the tax credit may not cover the full amount of tax paid on those contributions. 4 5
Source: (OECD, 2018[1]).
Public pay-as-you-go (PAYG) pension arrangements are also generally subject to the “EET” tax regime. This is an argument in favour of providing the same tax treatment, “EET”, to funded pension arrangements. In most OECD countries, employees’ social security contributions are deductible from income, the (implicit or explicit) internal rate of return of the PAYG scheme is exempt from personal income tax, and pension benefits are taxed as income. Of the 18 OECD countries applying the “EET” tax regime to their main retirement savings plan, 13 also apply it to their mandatory PAYG pension arrangement (OECD, 2017[2]).
Figure 2.1 masks the heterogeneity that exists within countries. The tax treatment of contributions to retirement savings plans may vary according to the source of the contributions (the employee, the employer or the government), their mandatory or voluntary nature, the type of plan into which they are paid (personal or occupational), or the income of the plan member. In addition, limits to the amount of contributions eligible for tax relief may differ for various types of contributions. In countries where returns are taxed, tax rates may vary according to the holding period of the investments, the type of asset class, or the income of the plan member. Finally, the tax treatment of pension income may differ according to the source of the contributions, the form of the post-retirement product or the age of retirement.
The complexity of the tax treatment of retirement savings may prevent individuals to save for retirement. Consequently, some countries have introduced more direct, non-tax financial incentives to promote savings for retirement (Table 2.1). These include matching contributions and fixed nominal subsidies. These incentives are provided to eligible individuals who participate in, or make contributions to, retirement savings plans. Matching contributions correspond to a certain proportion of the individual’s contributions (match rate), up to a maximum, while with fixed nominal subsidies all eligible individuals receive the same amount.
Table 2.1. Government non-tax financial incentives, 2018
1. Chile has two different matching programmes, one for young low earners (50% match rate) and one for voluntary contributors (15% match rate).
2. The matching programme for Mexico only applies to public sector workers.
3. The matching programme for the United States refers to the Thrift Savings Plan for federal employees. The first 3% of employee contribution is matched dollar-for-dollar, while the next 2% is matched at 50 cents on the dollar.
2.2. Does the design of financial incentives provide a tax advantage when people save for retirement?
This section assesses whether the design of financial incentives in OECD and selected non-OECD countries provides an advantage when people save for retirement. This assessment requires a common metric to compare the outcome of the different tax and non-tax incentives across countries. This section first introduces such a metric and then calculates it for all of the countries.
How to assess the way in which financial incentives provide an advantage to individuals
Comparing the present value of taxes paid when an individual saves in an incentivised retirement plan rather than a traditional savings vehicle makes it possible to assess how much tax is saved by the individual due to the financial incentives. Table 2.2 illustrates how much tax would be paid under two tax regimes that commonly apply to traditional savings vehicles (“TTE”) and to retirement savings plans (“EET”). The calculations assume that an initial contribution of EUR 1 000 is invested for 10 years and earns a constant 5% return. The individual is subject to a 25% marginal income tax rate that remains constant over time. Under the “TTE” tax regime, the individual pays EUR 250 in tax when the contribution is made, so that, after tax, only EUR 750 are actually invested. At the end of each year, the individual also pays taxes on the investment income, amounting in total to EUR 84.7 in present value. Upon withdrawal, no tax is due and the after-tax value is equal to EUR 1 083.8. Under the “EET” tax regime, tax is only due upon withdrawal, so that the present value of tax paid amounts to EUR 250 and the after-tax withdrawal to EUR 1 221.7. The individual therefore pays EUR 84.7 less in taxes in present value terms when contributing to an “EET” plan rather than to a “TTE” plan. The difference in after-tax withdrawal is also equal to EUR 84.7 in present value. Provided the discount rate is equal to the rate of return, the benefit that accrues to the individual can be expressed as either a tax advantage or as a retirement income advantage.
Table 2.2. Overall tax advantage: illustration (in EUR)
Notes: “E” stands for exempt, “T” for taxed and “PV” for present value. The calculations assume that an initial contribution of EUR 1 000 is invested for 10 years and earns a constant 5% return. The individual is subject to a 25% marginal tax rate, constant over time. The discount rate is equal to the rate of return.
The analysis calculates the “overall tax advantage”, by extending the simulation to the entire lifetime of the individual and considering the specific tax regimes of different countries. The overall tax advantage should not be confused with the incentive to save (Box 2.1). The overall tax advantage is defined as the difference in the present value of total tax paid on contributions, returns on investment and withdrawals when an individual saves in a benchmark savings vehicle compared to an incentivised retirement plan assuming a constant contribution rate during the entire career. It is expressed as a percentage of the present value of pre-tax contributions. The overall tax advantage represents the amount saved in taxes by the individual over working and retirement years when contributing the same amount (before tax) to an incentivised pension plan rather than to a benchmark savings vehicle. The impact of both tax and non-tax incentives is reflected in the overall tax advantage by evaluating non-tax incentives as refundable tax credits paid into the pension account.
Box 2.1. Difference between the overall tax advantage and the incentive to save
A positive overall tax advantage means that the individual would save in taxes paid when contributing to an incentivised retirement plan rather than to a benchmark savings vehicle. It does not mean that the individual has an incentive to save.
The incentive to save is measured by the after-tax rate of return. A tax system is neutral when the way present and future consumption is taxed makes the individual indifferent between consuming and saving. This is achieved when the after-tax rate of return is equal to the before-tax rate of return.
Taxing returns creates a disincentive to save because the present value of the income is greater if it is used for consumption today than if it is used for consumption tomorrow (Mirrlees et al., 2011[3]). A “TTE” tax regime therefore incentivises consumption rather than savings. In the example from Table 2.2, the after-tax rate of return with the “TTE” tax regime is equal to 3.75%, which is lower than the before-tax rate of return of 5%.
By contrast, an “EET” tax regime is neutral between saving and consuming (the after-tax rate of return is equal to 5%), provided that the individual faces a constant personal income tax rate over time. When the tax rate on withdrawals is lower than the tax rate at which contributions were deducted, the after-tax rate of return is greater than the before-tax rate of return, creating an incentive to save. When the opposite is true, for example due to a loss of entitlement to a means-tested public pension, the after-tax rate of return is lower than the before-tax rate of return, leading to an incentive to consume.
Upfront taxation of retirement savings, “TEE”, also achieves tax neutrality between saving and consuming, as long as returns are not above the “normal return to saving”. The normal return to saving is the return that just compensates for delaying consumption. It is also often called the risk-free return (Mirrlees et al., 2011[3]).
Overall tax advantage offered in different countries
Across OECD and selected non-OECD countries, a hypothetical average earner pays less in taxes over their lifetime by contributing the same pre-tax amount to a retirement savings plan rather than to a traditional savings account.6 This amount varies from 8% of the present value of all contributions in Sweden, to around 50% in Israel, Lithuania, the Netherlands and Mexico (Figure 2.2).7 Countries with the largest private pension markets, such as Australia, Canada, Denmark, Switzerland, the United Kingdom and the United States, provide overall tax advantages between 20% and 40% of the present value of contributions, with the United States at the higher end of the range and Australia, Denmark, and the United Kingdom at the lower end.8
Figure 2.2. Overall tax advantage provided to an average earner
Note: Calculations based on the 2018 tax treatment of the main pension plan in each country.
Source: (OECD, 2018[1]).
The differences observed across countries are due not only to the characteristics of the tax regimes applied to retirement plans and savings vehicles and to the presence of non-tax incentives, but also to the characteristics of the personal income tax system in each country (i.e. the tax brackets and the tax rates). In Canada and Greece for example, the overall tax advantage of contributing to a private pension plan is different (25% and 12% of the present value of contributions respectively), even though the same tax regime applies to retirement savings (contributions and returns are tax exempt and withdrawals are taxed, “EET”). However, an average earner in Canada has a marginal tax rate of about 30%, while an average earner in Greece has a 22% marginal tax rate. A lower marginal income tax rate results in a lower value of the tax relief.
The overall tax advantage provided to individuals is sensitive to the assumptions used, especially the assumed contribution rate. In voluntary pension systems people contribute at different rates. Therefore, to compare the overall tax advantage across countries there is a need to assume a single rate of contribution for voluntary components of the pension system.9 The analysis shown in Figure 2.2 assumes a 5% of earnings contribution for each country. Figure 2.3 shows the impact of increasing the assumed contribution rate from 5% to 10% for countries with voluntary private pension systems. Everything else equal, a higher contribution rate translates into higher assets accumulated at retirement and higher pension benefits. In systems where pension benefits are taxed, these higher benefits may be taxed at a higher rate because they may push total taxable pension income into a higher tax bracket or because the share of total taxable pension income in the last tax bracket is bigger. This would lead to a reduction in the overall tax advantage. In Ireland, the United States and Malta, the overall tax advantage falls by 10, 11 and 5 percentage point respectively when increasing the contribution rate to 10%. In the other countries with voluntary pension systems, the change in the overall tax advantage provided to the average earner from increasing the contribution rate is not significant. The relative value of the tax incentive across countries is therefore significantly affected by the assumed rate of contribution.
Figure 2.3. Overall tax advantage provided by voluntary pension systems according to the assumed contribution rate, average earner
Note: Calculations for countries with voluntary private pension systems only, assuming a contribution rate of 5% or 10%.
Source: (OECD, 2018[1])
The value of the overall tax advantage varies with the income level of the individual. Figure 2.4 shows that, in some countries, high-income earners (earning four times average earnings) benefit from a higher overall tax advantage than average earners and low-income earners (earning 60% of average earnings). This is the case in Canada, Chile, Denmark, Italy, Japan, Poland, Switzerland and the United Kingdom (black triangles are on top). Low-income earners receive higher financial incentives in Estonia, Ireland, Latvia, Lithuania, New Zealand, Norway and Turkey for example (white diamonds are on top). These include countries offering fixed nominal subsidies (e.g. Lithuania, Turkey) or matching contributions with a low maximum entitlement (e.g. New Zealand). This type of incentive is found to be more valuable to low-income earners because the payment represents a larger share of their income. Other countries provide the largest tax advantage to average earners. These include France, Iceland, the Netherlands and Slovenia (blue bars are higher than the other symbols). Finally, countries with fixed personal income tax rates that tax all retirement savings equally regardless of income level offer the same overall tax advantage across the income scale, for instance, as in Bulgaria.
Figure 2.4. Overall tax advantage provided to individuals, by income level
Note: Calculations based on the 2018 tax treatment of the main pension plan in each country.
Source: (OECD, 2018[1]).
2.3. Are financial incentives effective tools to promote savings for retirement?
Countries use tax incentives to promote savings for retirement, in particular by taxing retirement savings only upon withdrawal (“EET” tax regime). This translates into a tax advantage for individuals contributing an equivalent amount to an incentivised retirement plan rather than to a traditional savings vehicle by reducing total taxes paid over their lifetime. This section examines whether financial incentives are effective tools to promote savings for retirement by analysing whether individuals actually respond to financial incentives by increasing their participation in, and contributions to, retirement savings plans.
The best way to measure the effectiveness of financial incentives is with respect to the intended policy objective. Some countries may want to increase overall savings because they have low national savings relative to their investment needs. National savings are a source of funds for domestic investment which is a key driver of labour productivity growth and higher future living standards. Even a country that has large overall savings may want to reallocate savings into retirement savings plans. Increasing saving for retirement could increase long-term investment, enhance the depth and characteristics of the financial sector and facilitate long-term growth. Furthermore, research in behavioural economics indicates that people tend to save too little for retirement because of procrastination, inertia and short-sightedness.10 Encouraging a reallocation of savings might not increase overall national savings but could earmark a greater share for retirement thereby increasing the long-term income security of the population. In addition, recent reforms to PAYG public pension systems have increased the need to enhance the role of private funded pensions in the provision of retirement income in some countries (OECD, 2017[4]). Increased private sources of retirement income can also help reduce reliance on the public safety net which helps to rein in public expenditures.
The effectiveness of financial incentives in part depends on the design and generosity of the public pension system. In countries where the public pension system already offers high replacement rates, the need for supplementary retirement savings may be relatively low although this may change as potential financial sustainability issues associated with generous public systems arise. If contributions to the public pension system are already large, individuals may not be willing to part with additional pension contributions. In both cases, financial incentives would need to be larger to overcome impediments to putting money aside for retirement.
In light of those broad objectives, the following section summarises the main findings from the literature evaluating the effectiveness of financial incentives in promoting savings for retirement. It discusses first the impact of financial incentives on participation in, and contributions to, retirement savings plans, and then whether financial incentives lead to an increase in national savings or to a reallocation of savings.
The impact of tax incentives on participation in, and contributions to, retirement savings plans
“EET” tax incentives encourage participation in, and contributions to, retirement savings plans in progressive personal income tax systems, where tax rates increase with taxable income, because individuals respond to the upfront tax relief on contributions. When contributions are deductible from taxable income, tax relief on contributions increases when taxable income jumps from one tax bracket to the next. Empirical studies in Canada (Milligan, 2002[5]), France (Carbonnier, Direr and Slimani Houti, 2014[6]), the United Kingdom (Crawford, Disney and Emmerson, 2012[7]) and the United States (Power and Rider, 2002[8]) show that individuals whose income is subject to a higher marginal tax rate are more likely to participate in, and to contribute more to, an “EET” retirement savings plan.11 In all these studies, the authors include controls for the level of income, so that the tax effect is not distorted by the effect of income.
Among low-income earners, however, the combination of a progressive tax system and an “EET” tax incentive may not be effective in encouraging savings for retirement. For example, Carbonnier, Direr and Slimani Houti (2014[6]) compare contribution levels to “EET” tax-favoured pension plans for two groups of French individuals: those whose taxable income is higher than, but close to, a given tax threshold, and those whose taxable income is just below the same threshold. They conduct this comparison at different tax thresholds and for different age groups.12 They find that low-income earners aged 45 to 55 do not increase their contribution level when their marginal tax rate increases. This suggests that the structure of the income tax system is not the main factor for low-income earners in deciding about their contribution level. In addition, in retirement income systems where low-income earners receive large income replacement rates through public pensions, this observed low responsiveness to tax incentives may be less of a concern.
Despite the limited sensitivity to variations in income tax rates, low-income earners have been found to respond to changes in some of the parameters of tax incentives by adjusting their participation in, and contribution level to, retirement savings plans. Although the impact may be small. For instance, Disney, Emmerson and Wakefield (2007[9]) show that low-income earners increased their participation in, and contributions to, personal pensions in the United Kingdom following a 2001 reform that increased the contribution limit for them. Private pension coverage increased by around three percentage points more among individuals who were affected by the reform than among those who were not affected. Evidence also suggests an increase in contributions among those affected by the reform of around GBP 0.8 per week for singles and GBP 4.3 per week for couples. Similarly, Harju (2013[10]) shows that an increase in tax incentives for low-income earners in 2005 in Finland slightly increased their participation in personal pension plans.13 Among low-income earners, coverage increased between one and two percentage points because of the reform. The reform, however, did not prompt a significant increase in contribution levels.
The limited responsiveness of low-income earners to tax incentives may be due to insufficient income to afford contributions, insufficient tax liability to enjoy tax relief, or low understanding of tax-related issues. For example, in the United Kingdom in 2012, only 46% of survey respondents knew that money paid into private pensions qualifies for tax relief (Macleod et al., 2012[11]). In addition, Sandler (2002[12]) provides evidence that understanding of tax-related matters with respect to savings increases with the income level.
Tax incentives can also take the form of tax credits. The only available studies on tax credits refer to the Saver’s Credit in the United States, which supplements “EET” tax incentives for low and middle-income earners.14 According to the Internal Revenue Service, in 2015, only 5.4% of all tax filers received a tax credit for an average amount of USD 178, far below the maximum USD 1 000. This low participation number is partially explained by the fact that the statistics consider all tax filers while only low and middle-income earners are eligible for the credit. Brown and John (2017[13]) argue that the limited impact of the programme is due to a general lack of awareness of the credit and the complexity of the claim form, the fact that many low and middle-income earners do not have access to occupational pension plans, and the fact that low-income earners may not have sufficient tax liability to receive the tax credit. In addition, Ramnath (2013[14]) finds no statistically significant evidence that a higher tax credit rate increases individual contributions to private pensions.
Do tax incentives lead to an increase in national savings or to a reallocation of savings?
The literature is far from conclusive on whether tax incentives lead to an increase in national savings or instead to a reallocation of savings. Empirical studies provide a range of estimates that between 9% and 100% of savings in tax-favoured plans represent new savings. All studies examining this issue focus on retirement savings plans for which contributions are tax deductible (either “EET” as in the United States or “EtT” as in Denmark).15
A first group of studies find that tax incentives increase retirement savings through a moderate increase in national savings. Poterba, Venti and Wise (1996[15]) found that due to tax incentives, the assets accumulated in IRAs and 401(k) plans in the United States are mostly net additions to savings. Papers with similar findings include: Hubbard and Skinner (1996[16]), Benjamin (2003[17]), Ayuso, Jimeno and Villanueva (2007[18]), Guariglia and Markose (2000[19]), Rossi (2009[20]), and Gelber (2011[21]).
Another body of the literature argues that the increase in retirement savings following the introduction of tax incentives is mostly the result of a reallocation of savings rather than new savings. For example, Engen, Gale and Scholz (1996[22]) conclude that most of the reported increase in financial assets in IRAs can be attributed to stock market booms, higher real interest rates, and shifts in non-financial assets, debt, pensions and Social Security wealth. They conclude that tax incentives have a strong effect on the allocation of savings and wealth, but not on the level. Other papers with similar findings include: Attanasio and DeLeire (2002[23]), Pence (2002[24]), Attanasio, Banks and Wakefield (2004[25]), Antón, Muñoz De Bustillo and Fernández-Macías (2014[26]), Chetty et al. (2014[27]) and Paiella and Tiseno (2014[28]).
The empirical measurement of whether tax incentives for retirement savings lead to an increase in national savings is inconclusive because of a number of constraints and methodological issues. For example, it is difficult to construct the counterfactual scenario, to control for all of the other factors that can influence saving decisions, and to choose the appropriate dependent variable (savings, wealth or consumption).
There is, however, more consistent evidence in the literature that low-to-middle income earners are more likely to respond to tax incentives by increasing their overall savings, while high-income individuals tend to reallocate their savings. For example, Engelhardt (2000[29]), Engen and Gale (2000[30]), Chernozhukov and Hansen (2004[31]) and Engelhardt and Kumar (2011[32]) argue that, since low-income earners have little wealth, when they contribute to a tax-favoured retirement savings plan their contributions represent new savings because they have few other assets to reallocate. By contrast, high-income earners are more likely to finance contributions to tax-favoured accounts by shifting assets from other taxable accounts or taking on more debt, rather than reducing their consumption, although they need to balance the advantage of tax incentives with the illiquidity of retirement products.
Therefore, the proportion of new savings in tax-favoured retirement plans will depend on the marginal propensity to save of different income groups, and on whether tax incentives are designed in a manner that will make them more accessible by, or attractive to, individuals at different income levels.
The impact of non-tax incentives on participation, contributions and savings
Adding employer matching contributions to tax-favoured (“EET”) occupational pension plans has been shown to increase participation in retirement savings plans, but not necessarily total contributions (employer plus employee). Choi (2015[33]) and Madrian (2013[34]) review the rich literature in the United States related to employer matching contributions and conclude that the presence of a matching contribution and a higher match rate increase participation. They also find that the rate of increase in the match rate is directly related to the rate of increase in participation.16 However, both authors note that the evidence on the link between the match rate and the overall level of contributions is inconclusive. Different levels of the match threshold, however, are found to be related to changes in participants’ contribution rates. Choi et al. (2002[35]) show that increasing the match threshold (i.e. the rate of employee contribution up to which the employer offers the match), without changing the match rate, increases the proportion of employees contributing at higher rates.
Government matching contributions targeted at low-income earners may be more effective at increasing their contribution level than their participation rate. OECD (2012[36]) for example shows that, in Australia, despite the “super co-contribution” programme, low-income earners are less likely to make voluntary pension contributions than other income groups. However, those who do contribute voluntarily tend to have much higher contribution rates than other income groups, as they need to make a larger contribution effort to get the maximum entitlement (maximum 50% match rate up to AUD 500).
Finally, government fixed nominal subsidies are found to increase participation in retirement savings plans for low-income earners, but the impact on contribution levels and national savings is unclear. For example, Börsch-Supan, Coppola and Reil-Held (2012[37]) and OECD (2012[36]) show that Riester pensions in Germany, which offer fixed nominal subsidies (provided that individuals contribute at least 4% of income), achieve higher participation rates among low-income households than other types of private pension plans.17 Pfarr and Schneider (2013[38]) also find a positive effect of the child subsidy on participation.18 However, the design of the subsidies does not encourage individuals to contribute above the 4% threshold. OECD (2012[36]) shows that average contribution rates are similar across all income groups at around the 4% minimum required to obtain the full subsidy. This threshold may act as an anchor in people’s mind and does not provide any incentive to go beyond it. Finally, the evidence regarding the impact of subsidies on national savings is mixed. Corneo, Keese and Schröder (2008[39]), Kolerus, Koske and Hüfner (2012[40]), and Pfarr and Schneider (2013[38]) argue that low-income households reallocate existing savings from taxable accounts to Riester plans. By contrast, Börsch-Supan, Coppola and Reil-Held (2012[37]) report that most households across all income groups declare that they increased their savings after being enrolled in a Riester plan.
2.4. What is the cost of providing financial incentives to promote savings for retirement?
Tax incentives translate into lower personal income taxes paid by individuals and thus create a fiscal cost for the government. Moreover, non-tax financial incentives come directly from the general budget. The total fiscal cost of those tax and non-tax incentives depends on the generosity of the incentives and the amount contributed into retirement savings plans in each year. This section first presents how countries report the cost related to financial incentives for retirement savings, introduces a measure that allows for cross-country comparisons, and then calculates the measure for a selection of countries, determined by their data availability.
Country reporting of the cost related to financial incentives to promote savings for retirement
Several OECD countries produce tax expenditure reports that provide an assessment of the estimated fiscal cost of providing financial incentives to promote savings for retirement. These national reports usually measure the amount by which tax revenues are reduced in a given year due to a favourable tax treatment compared to a counter factual scenario that assumes individuals continue saving the same amount in a non-tax favoured benchmark vehicle. Among countries offering non-tax incentives, some may also use these reports to provide information about the amount paid into retirement accounts through fixed nominal subsidies or matching contributions (e.g. Austria, Germany and New Zealand).
Some countries also report the distribution of tax expenditures across income groups. These tend to show that the tax expenditures are concentrated within high-income households. In voluntary pension systems, high-income earners are more likely to participate in private pension plans than other income groups, reflecting their higher propensity and capacity to save.19 Moreover, their higher income results in a greater value of the tax relief per household even when the tax rate is the same for everyone. Finally, in progressive tax systems where tax rates increase in proportion to income, high-income earners typically face higher marginal tax rates, thereby benefiting more from every unit of the flows that attract tax relief. In United States for example, where tax qualified retirement savings are taxed only upon withdrawal (“EET” tax regime), households in the top 20% of the income distribution receive around 66% of the tax expenditure related to retirement savings (Congressional Budget Office, 2013[41]).20
Because they often use different methodologies, national tax expenditure reports do not allow for meaningful cross-country comparisons. For example, the items reported as tax expenditures for retirement savings vary by country. Some countries like Belgium, Ireland, France or Sweden only communicate tax revenues forgone in their tax expenditure reports. Other countries, like Canada, the United Kingdom and the United States also include the tax collected on pension withdrawals (reporting it as negative tax expenditure) providing a measure that nets the value of the different flows. There is therefore a need for a common measure of the cost of financial incentives across countries to facilitate comparisons.
How to compare the evolution of the fiscal cost across countries?
The “net tax expenditure” permits the comparison of the fiscal cost related to financial incentives for retirement savings over time and across countries. This measure sums up how much personal income tax is collected or forgone each year on contributions, returns on investment and withdrawals over the total population, as compared to a benchmark in which contributions and returns are taxed and withdrawals are tax exempt (“TTE”).21 As illustrated below, the maturity of the pension system and demographic trends influence the value of the net tax expenditure over time.
This measure of net tax expenditure stabilises only when the pension system is fully mature. For example, as illustrated in Figure 2.5, introducing “EET” tax incentives into a pension system creates a positive fiscal cost for the government that is larger during the early development of the system. The “EET” tax system, as compared to a “TTE” benchmark, produces a net tax expenditure stemming from the tax deferral and the tax exemption of returns on investment. During this maturing phase, aggregate assets and benefit levels increase over time until they reach a stable level. The lag in the growth of benefits behind that of assets and investment income creates a temporary increase in the net tax expenditure. Once the system has reached maturity (i.e. all retirees draw their pension based on a full career and constant contribution rules) the net tax expenditure stabilises at its steady-state level.
Demographic trends also affect the pattern of net tax expenditure. Figure 2.6 takes a mature “EET” system in year t and illustrates how the net tax expenditure varies when the sizes of the cohorts entering the labour market between t+5 and t+24 are 20% larger than that of previous and following cohorts. In t, the net tax expenditure is at its steady-state level. Larger cohorts entering the labour market translate into higher contributions and higher assets, bringing the net tax expenditure above the steady state for a while. When the larger cohorts retire, the net tax expenditure declines and reaches a minimum (below the steady state) the year in which all of the retired population is composed of individuals in the larger cohorts. The steady state is reached again when all the individuals in the larger cohorts have passed away.
Figure 2.5. Net tax expenditure for a maturing “EET” pension system, by components
Notes: The calculations assume that individuals save from the age of 20 to 64 and draw pension benefits from age 65 to 84; contributions represent 3% of GDP; the number of people in each single-year age cohort is equal; the same average tax rate (30%) applies to all sources of income; a nominal rate of return of 5.06% (3% real return plus 2% inflation); and GDP growth at 3.28% (1.25% real growth plus 2% inflation).
Figure 2.6. Net tax expenditure for an “EET” pension system subject to a population bulge, by components
Notes: The calculations assume that individuals save from the age of 20 to 64 and draw pension benefits from age 65 to 84; contributions represent 3% of GDP; cohorts entering the labour market between t+5 and t+24 are 20% bigger than the other cohorts; the same average tax rate (30%) applies to all sources of income; a nominal rate of return of 5.06% (3% real return plus 2% inflation); and GDP growth at 3.28% (1.25% real growth plus 2% inflation).
Fiscal cost of financial incentives in selected OECD countries
The projected total fiscal cost of financial incentives to promote savings for retirement varies greatly across countries, but is generally expected to remain in the low single digits of GDP. Figure 2.7 shows the total fiscal cost of financial incentives, including both the net tax expenditure of tax incentives and the direct cost of non-tax incentives when they exist, for selected countries between 2015 and 2060.22
Figure 2.7. Projected fiscal cost related to financial incentives to promote savings for retirement in selected OECD countries, 2015-2060
The fiscal cost varies from 2%-3% of GDP in Australia and Iceland to 0.1%-0.3% of GDP in Chile, Mexico, New Zealand and the Slovak Republic, and it even turns negative in Denmark, indicating an overall positive fiscal effect in the future.
Countries with mandatory private pension systems may expect a larger fiscal cost. For example, in Australia and Iceland, the mandatory private pension systems cover a large part of the population, contribution rates are above 10% and the tax incentives provide an overall tax advantage for an average earner of 25% of the contributions paid over a full career in Australia and 30% in Iceland (see Figure 2.2). In both countries, the fiscal cost is expected to vary between 2% and 3% of GDP over 2015-2060. Recent increases in contribution rates in these countries explain the upward trend in the fiscal cost.
Countries with mature voluntary private pension systems can expect a relatively stable fiscal cost. For example, the fiscal cost is anticipated to fluctuate between 0.7% and 1.5% of GDP in Canada and the United States, which have relatively mature voluntary pension systems and tax incentives that provide an overall tax advantage to the average earner, as measured earlier, of 25% in Canada and 41% in the United States. The ageing of baby-boom cohorts is the main factor driving the decline in the aggregate value of the net tax expenditure between 2015 and 2030-35 in these two countries. As baby-boomers start retiring and withdrawing their benefits, tax revenues collected on pensions will increase, thus reducing the annual value of the net tax expenditure. In both countries, the maturation of the private funded pension system is such that tax revenues collected on withdrawals are projected to exceed tax revenues forgone on contributions for the entire period of 2015-2060.
The maturing of the pension system will translate into large falls in the fiscal cost in Denmark and Latvia. In Denmark, the fiscal cost of the quasi-mandatory occupational pension plans will become negative (a positive fiscal impact) due to a large increase in tax revenues collected on withdrawals between 2015 and 2045. This is because coverage increased greatly in the 1990s through collective agreements, and contribution levels gradually increased to around 15% in the mid-2000s. This will translate into increased withdrawals as the system matures over time. The mandatory pension system in Latvia was introduced in 2001. During its initial phase, the net tax expenditure will increase and reach a peak at 0.7% of GDP in 2030, before declining and becoming negligible in 2060.
Including corporate income tax revenues and the potential tax impact of new savings would bring down the overall cost of financial incentives. When savings are invested in domestic equities or corporate bonds, they help companies improve their productive capacity, thereby raising the overall level of profits that are subject to corporate income tax and increasing future corporate income tax revenues. In addition, should financial incentives to promote retirement savings lead to new savings, this would affect tax revenues as well. Indeed, new savings are financed by a reduction in consumption and imply higher investment than otherwise, as new savings represent money that the individual would not have saved in the absence of the incentivised retirement plan. Therefore, new savings affect consumption tax receipts, as well as personal and corporate income tax revenues through higher investment income. As long as retirement savings are partly invested in the domestic economy and/or some of the saving would not have occurred in the absence of financial incentives, the fiscal cost of those incentives would be reduced compared to that shown in Figure 2.7. The exact reduction is, however, difficult to estimate as it depends on assumptions on how several parameters may evolve over time (see Chapter 5 (OECD, 2018[1])).
2.5. What are the comparative advantages and disadvantages of different approaches to designing financial incentives?
It is challenging to disentangle the effect of the design of different financial incentives from the effect of country-specific characteristics when analysing the implications for individuals and governments. Countries offering the same financial incentive can use different parameters such as the tax-deductibility limit, the tax credit rate, the proportion of contributions being tax deductible, the value of the subsidy, or the match rate. In addition, the characteristics of the personal income tax system in each country (i.e. the tax brackets and the tax rates) also affect comparability across countries.
This section, therefore, provides a theoretical assessment of different approaches to designing financial incentives to promote savings for retirement. The analysis compares different approaches to designing financial incentives based on their inherent characteristics and within a common framework to assess the implications for individuals and governments. The section starts with a description of the principal characteristics of the main current approach to designing financial incentives, taxing retirement savings upon withdrawal (“EET”), and then compares this approach to alternatives, such as taxing retirement savings upfront (“TEE”) or using tax credits.
Principal characteristic of the current main approach to designing financial incentives
The overall tax advantage provided by the “EET” tax regime, as compared to a “TTE” benchmark, is essentially equivalent to exempting returns on investment from tax. When tax rates are the same at the time of contribution and withdrawal and the discount rate is equal to the rate of return, the reduction in taxes paid on contributions is exactly equal in present value to the increase in taxes paid on withdrawals, regardless of the income of the individual saver. In that case, the after-tax rate of return is equal to the before-tax rate of return and the tax regime provides neutrality between saving and consuming to all individuals (see Box 2.1). If the discount rate is lower than the rate of return, the overall tax advantage provided by the “EET” tax regime, the present value of the difference in the tax paid compared to the benchmark savings vehicle, is reduced because the tax on withdrawals will more than compensate for the initial tax relief on contributions.
The link between the overall tax advantage provided by an “EET” tax regime and the income level of the individual depends on the structure of the personal income tax system. In countries where all individuals have their entire income taxed at the same rate, the overall tax advantage provided by the “EET” tax regime (and any other tax regime) is the same across the income scale. When personal income tax rates increase with the level of taxable income (a progressive income tax system), the overall tax advantage increases with income because of the higher marginal tax rates. Indeed, individuals with higher marginal tax rates benefit more relative to a taxable alternative on every unit of investment income to which a zero rate of tax applies. However, the amount of investment income that would have been generated by an after-tax contribution into a benchmark “TTE” savings account is lower for individuals with higher marginal tax rates. The result is that the overall tax advantage increases with marginal tax rates, but the rate of increase slows as the marginal tax rate increases (Brady, 2012[42]). This is illustrated in the left panel of Figure 2.8.
The relative level of retirement income compared to income from work also affects the link between the overall tax advantage provided by the “EET” tax regime, and the level of income. Retirement income is usually lower than income from work, hence retirement income is likely to be taxed at a lower average rate than income from work. In that case, the tax paid on withdrawals may not compensate fully for the initial tax relief on contributions making the overall tax advantage larger than when the tax rate remains constant over the lifetime. This also means that the tax regime may favour savings over consumption, in particular for middle to upper-middle income earners (the after-tax rate of return is greater than the before-tax rate of return, see Box 2.1).23 In addition, depending on the difference between the tax rates in the different tax brackets, and the size of the tax brackets, the reduction in taxes paid on withdrawals may increase the gap in the overall tax advantage across income groups. The right panel of Figure 2.8 shows that the overall tax advantage increases significantly for individuals earning between 80% and 2 times the average earnings when they face lower tax rates during retirement than while working. For high-income earners, there is a convergence towards tax neutrality (where neither savings nor consumption is favoured) because the higher the income level, the less likely is the individual to experience a fall in tax rate at retirement.
Figure 2.8. Overall tax advantage for an “EET” tax regime, by income level and components
Notes: The calculations assumes an individual contributing 5% of wages from age 20 to 64 and withdrawing benefits from age 65 to 84 as a fixed-payment annuity. Personal income falls into five tax brackets with tax rates of 0%, 14%, 30%, 41% and 45% respectively. On the left panel, each individual remains in the same tax bracket over working and retirement years. On the right panel, the tax rate during retirement is defined according to the level of taxable pension income (including public pensions).
Finally, “EET” tax incentives always generate a long-term fiscal cost to governments. In mature pension systems, taxes collected on withdrawals are large and therefore fiscal costs are lower. As shown in Figure 2.5, once the system has reached maturity, i.e. all retirees draw their pension based on a full career and constant contribution rules, the net tax expenditure stabilises at its steady-state level. That level implies a long-term fiscal cost for the government. However, the size of withdrawals in a given year exceeds the size of contributions, as withdrawals are the result of several years of contributions accumulating with compound interest. Taxes collected on withdrawals each year therefore more than compensate for tax revenues forgone on contributions. For countries already using the “EET” tax regime that are entering into a demographic transition in which the population is ageing, the higher tax revenues will come at a time when pressure on public services may increase.
Taxing retirement savings upfront or upon withdrawal
Because they have the same present value under certain conditions, taxing retirement savings upfront (i.e. taxing only contributions, “TEE”) is often seen as an equivalent approach to taxing retirement savings upon withdrawal (“EET”). Upfront taxation also achieves tax neutrality between savings and consumption as long as returns are not above the normal return on savings (Box 2.1). However, there are a number of different implications for the individual and the government between the two designs that are worth evaluating.
Upfront taxation (“TEE”) and taxation upon withdrawal (“EET”) provide the same overall tax advantage only when the income of the individual is subject to the same marginal tax rate throughout their working and retirement years. This is obviously the case in countries where the entire income is taxed at a single rate. However, in countries where tax rates increase with taxable income, not all individuals will be subject to the same tax rate over their entire life. In that case, the optimal tax treatment in terms of tax advantage depends on individuals’ circumstances.
Individuals are better-off having their retirement savings taxed upfront or upon withdrawal depending on whether their income tax rate will be higher or lower during their working or retirement years. As discussed earlier, individuals usually face a lower tax rate during retirement than while working. When this is the case, taxation upon withdrawal will provide a higher overall tax advantage than upfront taxation. By contrast, individuals would be better-off paying taxes upfront when they expect tax rates during retirement to be greater than when they are working.24 For example, when both public and private pension incomes are taxable, the individual may be subject to a higher tax rate during retirement than the one at which tax relief was granted on contributions.25
Low levels of financial knowledge may, however, affect individuals’ behaviour and retirement plan choices when they are provided with the opportunity to choose between upfront taxation and taxation upon withdrawal. For example, Beshears et al. (2017[43]) show that employees in the United States who are offered a choice between a Roth 401(k) plan (upfront taxation, “TEE”) and a traditional 401(k) plan (taxation upon withdrawal, “EET”) do not contribute less to their occupational pension plan than employees who could only contribute to a traditional plan.26 The authors find that the insensitivity of contributions to the introduction of the Roth option is partially driven by ignorance and/or neglect of the different tax rules.
In addition, behavioural biases may lead to a different perception of the two tax treatments. Contributions to plans with taxation upon withdrawal immediately reduce the amount of a participant’s income tax due. Plans with upfront taxation do not provide tax relief today, they exempt future pension income from taxation. Because of present bias, individuals may want to secure the tax advantage earlier rather than later and therefore prefer taxation upon withdrawal.
By contrast, other behavioural factors could lead individuals to prefer upfront taxation. For example, Cuccia, Doxey and Stinson (2017[44]) show that uncertainty may lead to anxiety and influence plan choice. Plans with taxation upon withdrawal may be perceived as more uncertain than plans with upfront taxation because the amount of taxes that will be due on withdrawals is unknown, as tax rates may change due to tax reforms or to a change in the individual’s economic status. Low levels of financial literacy and behavioural biases may therefore lead some individuals to choose the plan with the tax treatment that would not provide them with the largest overall tax advantage.
Taxation upon withdrawal may also discourage early withdrawals and lump sum payments. With taxation upon withdrawal, pension benefits are added to the individuals’ earnings and taxed at their marginal rate. Early withdrawals when the individual is still working and earning work income may therefore push taxable income into a higher tax bracket. In the same way, lump sum benefits may represent large amounts that move an individual into a higher tax bracket than would apply to a lower annual level of pension benefits (annuities or programmed withdrawals) if the same tax treatment applies to all types of post-retirement product. By contrast, upfront taxation with no tax on withdrawals creates no financial disincentive for early withdrawals and lump sum payments.
Although upfront taxation may be appealing to the treasury because it does not defer tax collection, in the long run this tax regime may translate into a higher fiscal cost than taxation upon withdrawal. If we compare the yearly fiscal effects of the two tax regimes, we see that in the short term, upfront taxation leads to a lower fiscal cost than taxation upon withdrawal. This is because, when taxing only withdrawals, tax collection is deferred, while the cost related to tax revenues forgone on contributions is fully incurred as they are made. With upfront taxation, the net tax expenditure is simply equal to tax revenues forgone on returns. In the long term, once the two systems reach maturity, the fiscal impact is reversed: taxation upon withdrawal leads to a lower annual fiscal cost than upfront taxation. This is because, with taxation of withdrawals, the taxes collected more than compensate for tax revenues forgone on contributions, as the size of withdrawals in a given year exceeds the size of contributions in a mature pension system.27
Upfront taxation may be preferable when considering mobility across countries. If individuals initially contribute to a plan with taxation upon withdrawal and then move to another country later in their working life or after retirement, the original country faces a tax revenue loss if those individuals pay income tax in their new country of residence, unless there are perfectly offsetting movements in the opposite direction. With upfront taxation, mobility across countries does not impact tax revenues across countries. Retirement savings are taxed in the country where contributions are made and whether the individual later moves does not affect tax revenues.
Providing partial tax relief
Some countries deviate from the standard “EET” model to reduce the fiscal cost by lowering the overall tax advantage for individuals. This can be achieved by providing partial tax relief on returns (i.e. taxing returns at favourable rates compared to alternative savings vehicles like in Denmark and Sweden) or on contributions, while still taxing withdrawals.
Partial tax relief on contributions is widespread and can take a variety of forms. Most countries have ceilings on tax-deductible contributions, thereby limiting the amount of contributions attracting tax relief.28 Some countries use partial tax deduction, whereby only a portion of the contributions is tax deductible (e.g. Portugal where 20% of an individual’s contributions are tax deductible). Finally, in some countries, contributions are taxed at the same fixed rate for everyone, and that rate is usually lower than the marginal income tax rate, therefore providing a rate relief on contributions (e.g. Australia where contributions are taxed at 15% for most people).
There are other approaches, not yet implemented in any country that may be worth considering. For example, contributions could be tax deductible at the same fixed rate for everyone independent of the individual’s marginal income tax rate. Alternatively, contributions could be tax deductible at a capped rate. In that case, contributions would be tax deductible at the individual’s marginal income tax rate, as long as that marginal rate is below the capped rate. For individuals with a marginal tax rate above the capped rate, contributions would be deductible only up to the capped rate.
While providing partial tax relief can still promote contributions to retirement savings plans rather than to alternative savings vehicles, it may have a negative impact on the incentive to save. Taxing returns on investment or providing partial tax relief on contributions can still lead to a positive overall tax advantage for retirement savings in relation to other savings. For example, Figure 2.2 shows that Denmark and Sweden, that tax returns on investment at a preferential rate (“EtT” tax regime), provide a positive overall tax advantage to the average earner (representing 24% and 8% of the present value of contributions respectively). However, OECD (2018[45]) reports that average-rate taxpayers face a positive marginal effective tax rate on private pensions in these two countries (21.1% and 2.9% respectively). This means that individuals have a greater incentive to contribute to private pension plans than to other savings vehicles, but have a reduced incentive to save (because consumption tomorrow is taxed more heavily than consumption today).
Care is needed when providing partial tax relief as different approaches achieve different levels of overall tax advantage for different income groups. Figure 2.9 illustrates how the overall tax advantage varies with income for the different approaches to reducing the fiscal cost in tax systems where tax rates increase with taxable income.
Figure 2.9. Overall tax advantage provided by different approaches to reducing the fiscal cost, by income
Notes: “E” stands for “exempt” and “T” for “taxed”. The calculations assume an individual contributing 5% of wages from age 20 to 64 and withdrawing benefits from age 65 to 84 as a fixed-payment annuity.
Moving from exempting to taxing returns on investment at a fixed rate reduces the overall tax advantage for all income groups but penalises low-income earners when the fixed tax rate exceeds their marginal tax rate, as they would pay tax on returns at a higher rate in the retirement plan than in the benchmark savings vehicle.
Taxing contributions at a fixed rate penalises low-income earners when the fixed tax rate is larger than their marginal income tax rate.
Reducing tax relief on contributions through partial tax deductibility hits middle-to-high income earners harder than low-income earners because low-income earners are the ones who benefit the least from the exemption of contributions.
Capping the deduction rate only affects individuals with a marginal tax rate above the capped deduction rate.
Tax deductions at fixed rate achieve a smoother overall tax advantage across income groups. While the “EET” tax regime provides a similar overall tax advantage to individuals earning between 80% and 4 times the average earnings, there are large differences with the other income groups. Tax deductions at a fixed rate reduce the overall tax advantage for individuals subject to a marginal tax rate greater than the fixed deduction rate, while they increase the overall tax advantage for individuals subject to a marginal tax rate lower than the fixed deduction rate. The differences across all income groups are therefore reduced compared to the “EET” tax regime.
Introducing a ceiling on tax-deductible contributions likely affects the amount contributed into the plan, as individuals have no incentive to contribute above the ceiling. High-income earners are more likely to reach the ceiling and therefore they are more likely to reduce their contributions once a ceiling is introduced. This would lead high-income earners to accumulate fewer assets, have lower pension benefits, and therefore pay less tax. Lower pension benefits translate into a higher overall tax advantage for high-income earners once a ceiling is introduced because the proportion of their total pension income in the last tax bracket will be lower compared to a situation without the ceiling (cf. individuals earning 8 or 16 times the average earnings in Figure 2.9). Not indexing tax-deductibility ceilings, or only indexing them at the rate of inflation, increases the proportion of individuals reaching the ceiling over time and reduces their contributions to retirement plans.29
Using tax credits or tax deductions
Non-refundable tax credits and tax deductions are economically equivalent when the credit rate is equal to the individual’s marginal tax rate. For example, for an individual facing a 30% marginal tax rate, it is equivalent to deduct contributions from taxable income or to get a tax credit of 30%.30
Tax credits achieve a smoother overall tax advantage across income groups than tax deductions at the marginal rate. Tax credits provide the same tax relief on after-tax contributions to all individuals with sufficient tax liability, independent of their income level and marginal income tax rate. They are equivalent to tax deductions at fixed rate, except for very low income-earners who benefit less from the tax credit if it is non-refundable.
Tax credits and tax deductions are, however, not very valuable for individuals with low or no income tax liability unless tax credits are refundable (i.e. when the tax credit is higher than income tax due, the treasury pays the difference to the individual). Individuals whose tax liability is lower than the value of a non-refundable tax credit will not receive the full credit. For individuals not paying income tax, deducting contributions paid into a pension plan at their marginal tax rate does not reduce their income tax due. Making tax credits refundable restores their attractiveness for low-income earners as long as claiming the credit is not too cumbersome. Additionally, tax credits may also be expressed as a fixed nominal amount and be used to target the tax advantage to low-income earners, as the nominal amount represents a higher share of their income.31
The structure of tax declaration and tax collection may influence individuals’ perception of the two approaches and lead to different outcomes. For example, when pension contributions are deducted from pay before calculating and paying personal income tax, the tax relief is automatically provided and saved in the pension account. This may not be the case when tax deductions and tax credits need to be claimed through the income tax declaration. When contributions are first taxed at the individual’s marginal rate, the tax refund may be provided later in the year or even the following year to the individual. If individuals anticipate that they will eventually get a tax refund, they can increase their after-tax contribution to save the whole tax relief in the pension account. However, if they do not anticipate it, the after-tax contribution may not be as high as with an automatic direct tax deduction.
Using tax incentives or non-tax incentives
Non-tax incentives are not linked to the individual’s tax status making them attractive for all individuals. Matching contributions are calculated as a proportion of after-tax contributions. With fixed nominal subsidies, all eligible individuals receive the same amount in their pension account. As non-tax incentives are not linked to the individual’s tax status, the value of the incentive is not limited by the tax liability.32 Therefore all individuals can fully benefit from them as long as they fulfil the entitlement requirements (e.g. having an income below a certain level, contributing a certain proportion of income).
Moreover, non-tax incentives are paid directly into the pension account, which may not always be the case with tax incentives. Paying non-tax incentives directly into the pension plan increases the assets accumulated by retirement and future pension benefits. By contrast, individuals eligible for a tax credit or a tax deduction (when it needs to be claimed) may not save the value of the incentive in the pension account if they do not increase their after-tax contributions in anticipation of lower tax withholding or the receipt of a tax refund.
In addition, matching contributions may have a larger impact on retirement savings than economically equivalent tax credits.33 A study by Saez (2009[46]) shows that individuals receiving a 50% matching contribution participate more in retirement savings plans and contribute more than individuals receiving an equivalent incentive framed as a 33% tax credit.34 This result suggests that taxpayers do not perceive the match and the tax credit to be economically identical. Some individuals may have perceived the 33% credit rate as equivalent to a 33% match rate, thereby reducing the incentive. Another factor could be that individuals had to wait for two weeks to receive the credit rebate. Due to loss aversion, contributing for example USD 450 and then receiving USD 150 back may feel more painful than contributing just USD 300 and obtaining a match of USD 150 to reach the same USD 450 total contribution.
Matching contributions alone, when not associated with other tax incentives, provide a higher overall tax advantage to low-income earners when tax rates increase with taxable income. This is despite the fact that the match rate is equal for everyone. When the matching contribution is associated with a “TTE” tax regime, the match rate applies to after-tax contributions, implying that individuals with higher marginal tax rates receive a lower tax advantage on their contributions. Moreover, returns on investment are taxable. Taxes paid on returns are higher compared to a traditional savings vehicle because matching contributions increase the level of total contributions and generate additional investment income. Therefore, the overall tax advantage provided by matching contributions declines with the individual’s income level. This is an important difference with tax incentives, which tend to offer larger overall tax advantages to higher-income earners in tax systems where tax rates increase with taxable income.
Substituting deductible contributions for government matching contributions may increase participation in retirement savings plans. For example, in Turkey, participation in pension plans was initially encouraged through tax-deductible contributions. In order to make the system more inclusive and boost savings, tax relief on contributions was replaced by government matching contributions in January 2013.35 Between 2012 and 2013, the number of new participants increased by 65%, suggesting that government matching contributions were more effective in increasing the attractiveness of saving for retirement for some people.
From the point of view of the government, the difference between tax and non-tax incentives stems from the salience of the cost of promoting savings for retirement. The budgetary cost of a financial incentive would ordinarily be the same whether incurred in the form of a direct spending (non-tax incentive) or an equal amount of tax expenditure (tax incentive). Tax expenditures however involve a cost that is less salient (or obvious) than the cost of direct government spending.
Adding non-tax incentives to tax incentives
Policy makers should keep in mind the starting point when designing financial incentives. Most OECD countries already have tax incentives in place. Policy makers could, however, add non-tax incentives on top of the existing tax incentives when the objective is to provide an equivalent overall tax advantage to all income groups.
For example, introducing matching contributions for a pension plan that is already subject to the “EET” tax regime increases the overall tax advantage provided to individuals and the fiscal cost to the treasury, but achieves a smoother overall tax advantage across income groups. The matching contribution increases the tax advantage on contributions for all earners in the same proportion (equivalent to the match rate). At the same time, it increases assets accumulated, pension benefits and the amount of tax due when the pay-out occurs. The increase in tax due on withdrawals hits higher-income earners harder, as they are the ones subject to the highest marginal tax rates. All in all, the introduction of a matching contribution increases the overall tax advantage for all individuals, but less so for high-income earners, achieving a smoother tax advantage across income groups.
Combining the “EET” tax regime with matching contributions would incur an additional fiscal cost. In the long run, this additional cost would be smaller than the direct spending on the matching contribution, as it is partially offset by an increase in taxes collected on the higher withdrawals. The additional cost could be contained by capping matching contributions, targeting matching contributions to specific groups, or capping the amount of contributions that can be deducted, although these approaches would modify the relationship between the overall tax advantage and the income level.
Using the financial resources allocated to financial incentives to pay higher public pension benefits
The question of how best to use government resources to enhance retirement income is an important issue to consider. Is it better to provide financial incentives to encourage people to save in supplementary funded pension schemes, or to increase benefits paid by a public pension scheme? The financial resources allocated to financial incentives could be used instead to increase pension benefits in a public scheme. To address this question, the analysis that follows uses hypothetical scenarios to illustrate some of the implications of removing financial incentives in favour of higher spending in public pension systems.
The baseline scenario represents a situation where financial incentives for retirement savings are in place. It assumes that an average earner subject to a constant 30% marginal tax rate contributes 10% of gross wages yearly to an “EET” retirement savings plan from age 20 to 64 and withdraws benefits afterwards in the form of a 20-year fixed nominal annuity. The overall cost to the government comes from the tax exemption of returns on investment. Assuming average earnings of EUR 35 000, inflation of 2%, productivity growth of 1.25%, real return of 3% and real discount of 3%, the total fiscal cost over the lifetime of the individual amounts to EUR 27 844 in present value terms and the after-tax yearly pension income the individual would receive from age 65 to 84 amounts to EUR 54 854.
Removing tax incentives and using the money to finance additional public pension benefits would reduce the overall level of benefits compared to the baseline. This new scenario assumes that the individual stops contributing to a supplementary pension plan because tax incentives have been removed. It keeps the fiscal cost constant by assuming that the equivalent amount of money (EUR 27 844 over the lifetime of the individual in present value) is used to finance additional public pension benefits for the individual. That money could finance a yearly after-tax additional public pension of EUR 19 706 from age 65 to 84, or only 36% of the annual pension income generated by a full career of contributions into a tax-incentivised retirement plan (EUR 54 854).
To cover the resulting gap in pension income while keeping the cost to the government constant, the individual would need to save some additional funds in a non-tax-favoured savings vehicle (“TTE”). Contributions to a “TTE” vehicle would not increase the fiscal cost for the government, as this tax regime is the assumed baseline for the taxation of savings. The individual would need to contribute 9% of gross wages pre-tax, or 6.3% after-tax, into a “TTE” vehicle to reach the same level of benefits as were produced by the tax-favoured savings and the lower level of public pension benefits in the baseline. This is less than the 10% contribution rate in the baseline.36 However, it is not clear whether, without financial incentives, individuals would save that amount, in particular given that the “TTE” tax regime discourages savings (in favour of consumption) compared to the “EET” tax regime (Box 2.1).
The level of contributions in non-tax-favoured savings vehicles could be further reduced if the government were to create a fund to accumulate and invest the money allocated to the financial incentives over the lifetime of the individual. This would allow the government, as long as the accumulated resources are earmarked for this purpose only, to finance larger additional public pension benefits and reduce the amount of contributions that the individual would have to save in a non-tax-favoured plan to reach the same level of overall pension income as in the baseline scenario. The reduction in the contribution rate would depend on the returns earned by the investment of the government fund, which in turn would depend on whether this fund could invest in a large range of asset classes like any other pension fund or just in long-term government bonds.
This simple example shows that it could be difficult for a government to remove financial incentives and use the equivalent amount of money to increase public pension benefits. If this were done it might leave individuals with a lower retirement income if they do not make extra savings in a non-incentivised plan. In addition, it is contrary to the OECD principle of diversifying the sources to finance retirement income (Chapter 1 of (OECD, 2016[47])).
2.6. Policy guidelines for countries to improve the design of financial incentives
This chapter has examined whether countries can improve the design of financial incentives to promote savings for retirement. After describing how OECD and selected non-OECD countries currently design financial incentives, it has assessed the overall tax advantage that these incentives provide to individuals, how these incentives affect the way individuals save for retirement and the fiscal costs of these incentives to governments. The chapter has also compared different approaches to designing financial incentives in relation to their inherent characteristics within a common framework to assess the different implications for individuals and governments.
All countries provide financial incentives to promote savings for retirement. Those financial incentives can take the form of tax incentives, taxing retirement savings more favourably than other types of savings, or non-tax incentives, paying money directly in the pension account of eligible individuals (matching contributions and fixed nominal subsidies). The most common tax incentive exempts contributions and returns on investment from taxation, and taxes withdrawals (“EET”).
In all countries, financial incentives provide an overall tax advantage to individuals when contributing to an incentivised retirement plan rather than to another type of savings vehicle by reducing the total tax paid over their lifetime. The differences in the overall tax advantage observed across countries are due to the tax treatments applied to retirement plans and savings vehicles, the specific features of these tax treatments (e.g. partial taxation, tax-deductibility limits, tax credits) and the presence of non-tax incentives, but also to the characteristics of the personal income tax system in each country (i.e. the tax brackets and the tax rates). In most countries, the value of the overall tax advantage varies with the income level of the individual.
Financial incentives, both tax and non-tax, can be effective tools to promote savings for retirement. Allowing individuals to deduct pension contributions from taxable income encourages participation in, and contributions to, retirement savings plans for middle-to-high income earners, because individuals respond to the upfront tax relief on contributions that reduces their current tax liability. Low-income earners are, however, less sensitive to tax incentives for retirement savings because they may lack sufficient resources to afford contributions, they may not have enough tax liability to enjoy fully tax reliefs, and they are more likely to have a low level of understanding of tax-related issues. Low-to-middle income earners, however, are more likely to respond to tax incentives by increasing their overall savings, while high-income individuals tend to reallocate existing savings or to offset retirement savings with increases in debt. Matching contributions and fixed nominal subsidies increase participation in retirement savings plans, especially among low-income earners, although the impact on contribution levels is less clear.
The total fiscal cost of financial incentives to promote savings for retirement varies greatly across countries, but remains in the low single digits of GDP. For example, in Canada and the United States, where the voluntary pension systems are relatively mature, the yearly cash-flow fiscal cost will fluctuate between 0.7% and 1.5% of GDP between 2015 and 2060. The time profile of the fiscal cost depends on the level of maturity of the pension system and the countries’ demographic profile.
The way individuals perceive different designs of financial incentives may distort plan choices and savings levels even though those designs may be economically equivalent. Low levels of financial knowledge and behavioural biases may lead some individuals to fail to choose the tax treatment that will provide them with the largest overall tax advantage. In addition, the value of any tax relief on contributions may not always be saved in the pension account depending on the type of incentive (tax deduction or tax credit) and the way the tax system is structured (relief provided automatically or through a claim). Non-tax incentives that are deposited directly in the pension account represent a better assurance that the incentive helps to build larger pots of money to finance retirement. Finally, different designs can help to target financial incentives to different income groups.
Based on the analysis of country practices and the comparison of the inherent characteristics of different approaches to designing financial incentives to promote savings for retirement, the following policy guidelines could help to improve the design of financial incentives.
Financial incentives are useful tools to promote savings for retirement. Financial incentives usually result in lower participation levels than compulsion and automatic enrolment. However, they keep individual choice and responsibility for retirement planning, as individuals should ultimately be the best placed to evaluate their personal circumstances and determine the most appropriate level of retirement savings that takes into account all of their sources of income. Using the financial resources allocated to financial incentives to pay higher public pension benefits would require individuals to contribute to non-incentivised plans to reach the same level of benefits that would be achieved with just saving in an incentivised plan, although at a lower rate than into the tax-favoured vehicle. However, it is not clear whether, without financial incentives, individuals would save enough.
Tax rules should be straightforward, stable and common to all retirement savings plans in the country. Different tax rules applied according to who contributes (the employer or the individual), the type of retirement plan, or the income of the plan member may create confusion for people who may not have the ability to understand the differences and choose the best option for them. Frequent changes to tax rules may also reduce trust in the system and prevent individuals from adequately planning ahead.
The design of tax and non-tax incentives for retirement savings should at least make all income groups neutral between consuming and saving. This tax neutrality is achieved when the way present and future consumption is taxed makes the individual indifferent between consuming and saving. As PAYG public pension systems are under increasing strain due to population ageing and financial sustainability concerns, the tax treatment of retirement savings should at least not discourage savings and it may even be justified to incentivise savings more for certain groups of individuals, in breach of tax neutrality. A number of different designs can reach tax neutrality, including the “EET” and “TEE” tax regimes under certain conditions, most importantly constant tax rates over the lifetime. However, as people are likely to face lower marginal tax rates during retirement than while working, the “EET” tax regime is likely to breach tax neutrality and to incentivise saving, in particular for middle to upper-middle income earners. Interactions with the public pension system and the general tax system should also be carefully analysed. People will refrain from saving for retirement if doing so reduces their entitlements to public pensions or other forms of tax relief.
Countries with an “EET” tax regime already in place should maintain the structure of deferred taxation. The upfront cost incurred at the introduction of the pension system with deferred taxation is already behind in most countries and the rewards in the form of increased tax collections on pension income are coming in the future as these systems mature. Short-term and long-term impacts on the fiscal cost should be considered before modifying the “EET” tax regime.
Countries should consider the fiscal space and demographic trends before introducing a new retirement savings system with financial incentives. The maturity of the pension system and the demography influence the fiscal cost related to financial incentives. The fiscal cost also develops differently depending on the tax regime chosen, with, for example, a larger upfront cost in the case of the “EET” tax regime.
Identifying the retirement savings needs and capabilities of different population groups could help countries to improve the design of financial incentives. Individuals whose income is below or around the poverty line cannot afford to save in voluntary supplementary pension schemes and will rely on the safety net when reaching retirement. Specific incentives for those very-low-income earners are therefore not likely to be necessary. The need to save into complementary funded pension arrangements may differ across individuals, in particular when the public pension system delivers different replacement rates to different income groups. Financial incentives may need to be higher for those with higher savings needs.
Tax credits, fixed-rate tax deductions or matching contributions may be used when the aim is to provide an equivalent tax advantage across income groups. Financial incentives that equalise the tax relief provided on contributions for all individuals, independently of their income level and marginal income tax rate, achieve a smoother distribution of the overall tax advantage across the income distribution. They include tax credits and fixed-rate deductions (as opposed to deductions at the individual’s marginal tax rate), as well as matching contributions. These approaches increase the attractiveness of saving for retirement for middle to low-income groups, while reducing it for high-income earners, compared to the widespread “EET” tax regime. The lower tax advantage for high-income earners may, however, reduce their incentive to save.
Non-tax incentives, in particular fixed nominal subsidies, may be used when low-income earners save too little compared to their savings needs. Non-tax incentives are better tools to encourage retirement savings among low-income earners who are typically less sensitive to tax incentives. In particular, fixed nominal subsidies are likely to be more attractive because they are easier to understand than tax incentives. These can be targeted at disadvantaged groups, such as young workers or women.
Countries using tax credits may consider making them refundable and converting them into non-tax incentives. Individuals with a low tax liability can still achieve the full benefit from tax credits when they are refundable, increasing the attractiveness of saving for retirement for low-income earners. The value of the credit is strengthened when it is paid directly into the pension account (converting the tax credit into a non-tax incentive), in order to help individuals to build larger pots to finance retirement.
Countries where pension benefits and withdrawals are tax exempt may consider restricting the choice of the post-retirement product when granting financial incentives. Taxing pension benefits discourages early withdrawals and lump sum payments when the amounts received are added to the individuals’ earnings and taxed at their marginal rate. By contrast, when withdrawals are tax exempt, there is no financial disincentive for withdrawing early or choosing post-retirement products that fail to protect people from the risk of outliving their resources in retirement. Financial incentives may, therefore, lose their purpose if the policy objective when granting them was to encourage people to complement their public pension. To counter this, policy makers could restrict the choice of when and how to withdraw the money; take back part or all of the financial incentives when individuals take a lump sum or withdraw early; or promote selected post-retirement products that are more in line with the objective of people having a retirement income.
Countries need to regularly update tax-deductibility ceilings and the value of non-tax incentives to maintain the attractiveness of saving for retirement. Tax-deductibility ceilings for contributions tend to be updated yearly in line with price inflation only, so that, when wages grow faster than inflation, more individuals are likely to reach the ceiling over time and reduce their contributions to retirement plans. This will reduce, over time, the capacity of savings programmes to replace income. Similarly, keeping the same value of non-tax incentives (maximum matching contribution, subsidy) over time may reduce the attractiveness of saving for retirement and lower the positive impact on participation.
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Notes
← 1. For a more thorough discussion of the issues relating to financial incentives to promote savings for retirement, see (OECD, 2018[1]).
← 2. Other types of financial incentive exist but are not considered in this analysis. These include non-tax incentives provided on social contributions (e.g. deduction of pension contributions for the calculation of social contributions, reduced social contribution rate on pension withdrawals) and tax incentives provided to employers (e.g. tax allowances when making contributions on behalf of certain employees).
← 3. It is noteworthy that countries exempting all income flows (“EEE”) have low personal income tax rates, below 20% for the average earner. Tax relief is therefore given at low rates.
← 4. Note by Turkey: The information in this document with reference to “Cyprus” relates to the southern part of the Island. There is no single authority representing both Turkish and Greek Cypriot people in the Island. Turkey recognizes the Turkish Republic of Northern Cyprus (TRNC). Until a lasting and equitable solution is found within the context of United Nations, Turkey shall preserve its position concerning the “Cyprus” issue.
← 5. Note by all the European Union Member States of the OECD and the European Union: The Republic of Cyprus is recognised by all members of the United Nations with the exception of Turkey. The information in this document relates to the area under the effective control of the Government of the Republic of Cyprus.
← 6. The calculations assume that the average earner enters the labour market at age 20 in 2018 and contributes yearly until the country’s official age of retirement at a rate equal to the minimum or mandatory contribution rate fixed by regulation in each country or 5% of wages in the case of voluntary plans. The total amount of assets accumulated at retirement is converted into an annuity certain with fixed nominal payments. Inflation is set at 2% annually, productivity growth at 1.25%, the real rate of return on investment at 3% and the real discount rate at 3%.
← 7. In Colombia, the average earner does not pay personal income tax. There is therefore no tax advantage when contributing to a private pension plan rather than to a traditional savings account.
← 8. Numbers are not directly comparable to those published in Chapter 2 of the OECD Pensions Outlook 2016. Beyond updating the tax rules from 2015 to 2018, several assumptions have been changed. In particular, the assumed contribution rate for voluntary pension schemes has been reduced from 10% to 5% because in some countries, a 10% voluntary contribution rate over a full career is likely to be rare and produces quite large pension benefits. Everything else equal, this reduced contribution rate may increase the overall tax advantage provided by “EET” tax regimes because lower contributions translate into lower assets accumulated at retirement and lower pension benefits, which in turn may fall into a lower tax bracket. See (OECD, 2018[1]) for a full description of the methodology and changes in the assumptions.
← 9. The calculations assume a common contribution rate across countries with voluntary funded pension systems to be able to compare. This means that the assumed contribution rate does not always represent the actual average contribution rate observed in some countries.
← 10. See Chapter 5 in this volume for an analysis of the how behavioural biases can affect decision-making for retirement.
← 11. Feng (2014[48]) conducts the same kind of analysis in Australia for voluntary pension arrangements (salary sacrifice) which are taxed favourably (with a fixed tax rate of 15% on contributions rather than the marginal tax rate), but fails to find a significant increase in participation for individuals whose income is subject to a higher marginal tax rate.
← 12. The French personal income tax system has four tax thresholds. The authors test the impact of the three highest thresholds on contribution levels.
← 13. The tax treatment of contributions to personal pension plans changed from being deductible from labour income (for which tax rates increase with income) to being deductible from capital income (for which a fixed tax rate applies).
← 14. The Saver’s Credit provides taxpayers who fall within certain income tax brackets with non-refundable tax credits equal to 50%, 20% or 10% of the amount contributed to private pension plans on up to USD 2 000.
← 15. In Denmark, returns are taxed at a fixed rate of 15%. This represents a lower tax rate than the marginal tax rate for most people, hence the middle “t” in small letter in “EtT”.
← 16. Evidence in Australia also shows that the levels of the match rate and of the maximum entitlement influence participation. In July 2012, the government reduced by half both the match rate (to 50%) and the maximum entitlement (to AUD 500) for its “super co-contribution” programme, leading to a 40% decline in the number of individuals claiming the benefit.
← 17. The basic subsidy amounts to EUR 175 and is reduced proportionately for contribution levels below 4%.
← 18. The child subsidy amounts to EUR 300 for children born since 2008.
← 19. This effect can be reduced by conditioning the access to a preferential tax treatment for high-income earners on reaching minimum participation and contribution levels among low and middle-income earners, as is done in the United States in occupational pension plans.
← 20. It should also be noted that high-income earners pay a higher share of personal income taxes. In the United States, households in the highest income quintile paid 69% of federal taxes in 2013. The same year, they received 66% of the tax expenditures related to the tax treatment of private pensions (Congressional Budget Office, 2013[41]; 2016[50]).
← 21. When the “EET” tax regime applies to retirement savings, the net tax expenditure in year t can be expressed as NTEt = µCCt + µA(1-µC)iAt-1 - µBBt where: Ct and Bt are contributions to and benefits paid out of retirement savings plans in year t; At-1 is the aggregate level of assets in the plans at the end of the previous year; i is the nominal pre-tax rate of return on plan assets in the year; and µC, µA and µB are the average marginal personal income tax rates applicable to contributions, returns on investment and benefits respectively. See Chapter 5 of (OECD, 2018[1]) for more details.
← 22. As the amount of information necessary to make those projections is quite large, the analysis only covers 10 OECD countries for which appropriate data could be obtained.
← 23. OECD (2018[45]) shows that, when the taxpayer is assumed to earn less in retirement than when making contributions, the marginal effective tax rate (METR) on private pensions is negative in 22, 27 and 22 OECD countries for low-rate, average-rate and high-rate taxpayers, respectively. A negative METR increases the incentive to save.
← 24. Individuals may also face different marginal tax rates over their working life, making it harder to assess which tax treatment would be more advantageous for them.
← 25. Another example is when means-tested public pension benefits treat “EET” and “TEE” withdrawals differently, including the former for the means test but not the latter.
← 26. With upfront taxation, lower after-tax contributions are needed to achieve the same after-tax benefit in retirement as with taxation upon withdrawal (assuming that tax rates remain the same over the lifetime). The authors therefore expected that contributions would go down after the introduction of the Roth option in the occupational pension plan.
← 27. If the government invests the taxes collected on contributions with the upfront taxation regime instead of spending them, it could obtain the same gains when the system reaches maturity as with the tax regime that taxes retirement savings upon withdrawal.
← 28. Not indexing ceilings during several years or indexing them only in line with inflation is also a way to further reduce tax relief on contributions over time.
← 29. As wages increase in line with inflation and productivity, more people will reach the ceiling when this one is constant or just indexed to inflation.
← 30. With tax credits, contributions are included in taxable income. This implies that tax is paid on contributions and the tax credit is calculated based on the level of after-tax contributions.
← 31. This approach is common for mortgages but it is not implemented in any country yet for retirement savings.
← 32. This can also be achieved with refundable tax credits. Refundable tax credits could replicate the economic effects of non-tax incentives, as long as they are refunded directly into a pension account.
← 33. A credit rate of t is economically equivalent to a match rate on the contribution of t/(1-t). For example, a 25% refundable tax credit is economically equivalent to a matching contribution of one-third. This is because the tax credit rate is expressed as an inclusive rate (i.e. including the value of the credit), while the match rate is expressed as an exclusive rate (i.e. excluding the value of the matching contribution).
← 34. The study compares participation in and contributions to IRAs in the United States. An “EET” tax treatment applies to IRAs. The matching contribution and tax credit in the experiment supplement the already existing tax incentive.
← 35. The tax treatment of returns on investment and withdrawals has remained the same over time, with returns taxed upon withdrawals and withdrawals tax exempt.
← 36. The pre-tax and after-tax contribution rates are equal as contributions are tax deductible.