The study – which carries the somewhat unwieldy title “The Relative Effects of Economic and Non-Economic Factors on Taxpayers’ Preferences Between Front-Loaded and Back-Loaded Retirement Savings Plans” – takes a look at the various factors influencing preferences for paying taxes “up front” on retirement savings (this is termed “back-loaded by the researchers, in that the tax advantages come in retirement) versus pre-tax treatment as with a 401(k).
Writ large, and pretty much across the board, the researchers – Andrew D. Cuccia, associate professor and a Grant Thornton faculty fellow at the University of Oklahoma, and Marcus M. Doxey and Shane R. Stinson, both assistant professors at the University of Alabama – found that individuals preferred Roth (back-loaded) – even in circumstances in which they thought a rational determination would favor a pre-tax option.“Consistent with prior research, our results suggest that individuals, on average, do not respond rationally to the relative economic incentives associated with alternatively structured plans,” they wrote. And while “at least part” of the “failure to connect relative tax rates – those paid now versus those in the future – was attributed to “a lack of awareness and/or understanding,” the researchers found individuals largely reluctant to embrace the pre-tax approach, even when education specifically designed to help frame that understanding was employed. Or, as the researchers explained, “… although errors can be reduced with increased awareness, our evidence illustrates that individuals systematically incorporate non-economic factors into their retirement plan choices, often leading to a preference for [pre-tax deferrals] even when such a choice is economically adverse.”
The researchers determined that “participants do not incorporate expected tax rate changes into their plan choice without an explicit explanation of the impact tax rate changes have on relative after-tax returns,” and “even when participants were educated about the tax rate change-return relation, 49% who reported that they expected their tax rates to be lower in retirement nonetheless elected to make their contributions to a back-loaded (Roth) plan.”
Now, in fairness the research wasn’t based on actual administrative data – rather they constructed several scenarios to test responses to various factors, and ran a group of online survey respondents through those scenarios to evaluate and weigh those responses. So, it was basically asking individuals about their (hypothetical) response to a variety of conditions regarding (hypothetical) tax rates, market conditions, as well as non-economic attitudes and preferences.
While they found a general preference for the back-loaded Roth accounts, they found “mixed evidence regarding whether individuals appropriately weight expected tax rate changes in their plan choices,” even though tax rates were seen as the primary factor driving the relative after-tax returns of front- and back-loaded plans. Indeed, the certainty of knowing the tax rate that would be paid, even if paid “now” seemed to outweigh the concerns associated with the uncertainty of future tax rates, though those who did expect to pay higher taxes in the future were – as one might expect – inclined toward the back-loaded (Roth) option.
If the researchers seemed puzzled about some of the preferences for the Roth option, they also found that a sense of urgency regarding saving for retirement was “positively associated” with savings rates, and that perhaps what they saw as “the current crisis in retirement preparedness” suggested to them that “current marketing and education campaigns are not sufficiently stoking investors’ sense of urgency.”
Those of us who work with retirement plans – and retirement plan participants – might not be quite so perplexed by the notion that individuals don’t always act in their financial best interest. Additionally, while the researchers seemed to be quite thorough in outlining (and doubtless executing) their test scenarios, it is arguably one thing in a “laboratory environment” to make a choice with someone else’s money, and perhaps something else again to make those same choices with your own retirement savings.
Still, those concerned about a negative response by participants to the imposition of a Roth choice, might find some comfort in these findings.
Hypothetically speaking, of course.
- Nevin E. Adams, JD
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