Retirement Income Effects of Changing the Income Tax Treatment of DC Pension Plans

This document is about estimating the after-tax retirement income effects of switching the federal income tax treatment of defined-contribution pension plans from the traditional tax-exempt and taxable (EET) to an alternative treatment in which all contributions would be taxable and all withdrawals would be tax-exempt (TEE). The analysis uses a microsimulation model to simulate the lifetime pension accumulation and withdrawal behavior of a sample of individuals born in 2000, under both the EET and TEE tax treatments. The results suggest that the average effect on after-tax retirement income of this switch in the federal income tax treatment would be less than a 1% decrease when tax thresholds are indexed to wages, and slightly more than a 2% increase under current-law price indexing, with the magnitude of the changes rising with lifetime earnings and considerable variation around the average effect.