Distribution of Retirement Tax Benefits Estimation Methodology 

We define the tax benefit of retirement savings as the present value of the increase in after-tax 

income (or equivalently, consumption) generated by saving in a tax-preferred account relative to 

what the taxpayer would receive by saving in a fully taxable account. 

We estimate the tax benefits of the saver’s credit, as well as the tax benefits of the four types of 

tax-preferred retirement savings: (a) Roth IRAs and defined contribution (DC) plans (mostly 

401(k) plans), (b) traditional IRAs and DC plan accounts, (c) defined benefit pension plans, and 

(d) nondeductible IRAs. Under the tax code, individuals may be able to contribute to any of 

these accounts and employers may contribute to traditional DC plan accounts and to defined 

benefit plans. Our calculation uses the actual amount of money (as estimated from tax, survey 

and macroeconomic data) allocated by each taxpayer to each type of tax-preferred account in the 

year of contribution. 

As summarized in the table below, all or a portion of contributions to traditional IRAs and DC

accounts and to defined benefit pension plans are exempt from income and payroll taxes. In 

contrast, none of the contributions to Roth IRAs and DC accounts are exempt from income and 

payroll taxes. 

Individual Income Taxes Payroll Taxes

Roth IRA or DC account

 Contributions

 Distributions

Not Exempt 

Exempt

Not Exempt

Not Applicable

Traditional IRA or DC account 

 Employer Contributions

 Employee Contributions

 Distributions

Exempt

Exempt

Not Exempt

Exempt

Not Exempt

Not Applicable

Defined Benefit Plan

 Employer Contributions

 Employee Contributions

 Distributions

Exempt

Not Exempt

Part attributable to employee contributions exempt

Exempt

Not Exempt

Not Applicable

Nondeductible IRA

 Contributions

 Distributions

Not Exempt

Part attributable to contributions exempt

Not Exempt

Not Applicable

All undistributed, accumulated earnings in the above four types of tax-preferred savings accrue 

tax-free. In contrast, regular savings vehicles yield earnings that are taxable, but sometimes 

under preferential terms. Interest on regular savings accounts and regular dividends are taxable 

as they accrue, but tax on capital gains may be deferred until the gains are realized. In addition, 

while interest is taxed at ordinary income rates, dividends and capital gains are taxed at 

preferentially low rates. For the sake of analytical simplicity, we abstract from these details and 

assume that the alternative to a tax-preferred savings account is a savings account that pays 

interest that is fully taxable at ordinary rates. We also assume the tax is paid out of the account, 

rather than by reducing current consumption. Under these assumptions, retirement accounts 

grow faster than taxable accounts. 

While contributions to Roth accounts are taxable, distributions from these accounts are not. If 

tax rates are constant throughout life, the benefit of the tax-exempt distribution is the same as the 

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U.S. Department of the Treasury

Office of Tax Analysis

April 25, 2016
benefit of making tax-exempt contributions to traditional accounts, for a given amount of pre-tax 

contributions. (In other words, the main benefit of all of these tax-preferred accounts is that 

earnings are tax-free.) 

For each of the four types of tax-preferred retirement accounts, we calculate the tax benefit of a 

single year’s contribution to the account. The tax benefit is measured as the increase in 

consumption in retirement allowed by contributing the saving to the tax preferred account 

compared to contributing it to the fully taxable account. This increase in consumption is 

discounted back to the year of the contribution. In our methodology, the benefits from existing 

savings in tax-preferred retirement accounts are ignored. Thus, individuals who are retired in the 

current year are assumed to receive no benefits from tax preferences for retirement savings 

because they make no contributions to tax preferred retirement savings accounts. Instead, the 

benefit of the increase in consumption is counted, in present value terms, in the year that the 

contribution is made. 

We assume that the amount of pre-tax saving is fixed, and does not depend on the availability of 

tax-preferred retirement accounts. As a result, an elimination of the four types of tax-preferred 

retirement savings accounts would lead to a decrease in future consumption rather than a 

decrease in current consumption. However, by the same assumption, eliminating the saver’s 

credit would result in a decline in current rather than future consumption. In other words, the tax 

benefit of the saver’s credit is equal to its current value, in the year of the contribution. 

We also utilize the following assumptions: 

 Savings and accumulated earnings in retirement accounts, whether tax-preferred or 

taxable, are only used for consumption in retirement, which is assumed to be 65. Thus, 

the single year’s contribution grows (without withdrawals) until the taxpayer reaches age 

65. The length of this accumulation period varies from taxpayer to taxpayer, depending 

on the taxpayer’s age when he made the contribution.

 Upon reaching retirement, we assume that the taxpayer begins to draw down his or her 

accumulated savings to finance consumption. For simplicity, we assume that 

withdrawals each year are in an amount determined by the size of the annual fixed 

annuity that could be paid between age 65 and the taxpayer’s expected date of death. 

The fixed annuity is not adjusted for inflation and the taxpayer’s mortality is age and 

gender dependent. Earnings on balances remaining in tax-preferred retirement accounts 

continue to accumulate at the pre-tax rate of return. 

 The value of employer contributions to retirement accounts is included in the calculation. 

The burden of payroll and individual income taxes rests with employees so the 

elimination of tax incentives for retirement savings leaves total compensation paid by 

employers to employees, which includes employer payroll taxes, unchanged. Hence, 

employer contributions to a tax-preferred savings account or plan would, in the absence 

of tax preferences, be paid out as wages and savings in a taxable account would be lower 

by the amount of individual income taxes and employer and employee payroll taxes 

paid. 

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U.S. Department of the Treasury

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April 25, 2016
 Pre- and post-retirement, all individuals have a constant discount rate and a constant rate 

of return on savings. We assume that both the individual discount rate and the rate of 

return are equal to the current Second Segment Rate published monthly by the IRS. 

 Each individual is assigned a fixed marginal income tax rate, which is given by his or her 

statutory marginal income tax rate in the year of the contribution, and does not change as 

he ages. 

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U.S. Department of the Treasury

Office of Tax Analysis

April 25, 2016