The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings
43 Pages Posted: 18 Mar 2006
There are 2 versions of this paper
The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings
The Tradeoff between Mortgage Prepayments and Tax-Deferred Retirement Savings
Date Written: March 2007
Abstract
Many households face the trade-off between paying an extra dollar off the remaining mortgage on their house and saving that extra dollar in tax-deferred accounts (TDAs) used for retirement. We show that, under certain conditions, it becomes a tax arbitrage to reduce mortgage prepayments and to increase TDA contributions because of the tax-deductibility of mortgage interest and tax-exemption of qualified retirement savings. Using data from the Survey of Consumer Finances, we document that a significant number of households that are accelerating their mortgage payments instead of saving in a TDA forgo a profitable tax arbitrage opportunity. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity or other financial constraints. Rather, the observed behavior can be attributed to a certain extent to the reluctance of many households to participate in financial markets as either lenders or borrowers.
Keywords: Retirement Savings, Mortgage Financing, Tax Arbitrage, Savings Decisions
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Optimal Consumption and Investment with Capital Gains Taxes
By Robert M. Dammon, Harold H. Zhang, ...
-
Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing
By Robert M. Dammon, Harold H. Zhang, ...
-
Asset Allocation and Asset Location: Household Evidence from the Survey of Consumer Finances
-
Asset Allocation and Asset Location: Household Evidence from the Survey of Consumer Finances
-
The Transition to Personal Accounts and Increasing Retirement Wealth: Macro and Micro Evidence
By James M. Poterba, Steven F. Venti, ...
-
Asset Location in Tax-Deferred and Conventional Savings Accounts
By John B. Shoven and Clemens Sialm
-
Utility Evaluation of Risk in Retirement Saving Accounts
By James M. Poterba, Joshua D. Rauh, ...
-
The Location and Allocation of Assets in Pension and Conventional Savings Accounts