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The Tax Policy Center's

Briefing Book

A citizen's guide to the fascinating (though often complex) elements of the federal Tax System.

Tax Policy Center Briefing Book

Key Elements of the U.S. Tax System

  • Briefing Book
  • Key Elements of the U.S. Tax System
  • Chapters
    • Overview
      • Prologue
        • Introduction
        • Glossary
    • Some Background
      • Federal Budget
        • What are the sources of revenue for the federal government?
        • How does the federal government spend its money?
        • What is the breakdown of tax revenues among federal, state, and local governments?
        • How do US taxes compare internationally?
      • Federal Budget Process
        • How does the federal budget process work?
        • What is the history of the federal budget process?
        • What is the schedule for the federal budget process?
        • What is reconciliation?
        • How is a budget resolution enforced?
        • What is PAYGO?
      • Federal Budget Outlook
        • How accurate are long-run budget projections?
        • What have budget trends been over the short and long term?
        • How much spending is uncontrollable?
        • What are tax extenders?
        • What options would increase federal revenues?
        • What does it mean for a government program to be off-budget?
      • Taxes and the Economy
        • How do taxes affect the economy in the short run?
        • How do taxes affect the economy in the long run?
        • What are dynamic scoring and dynamic analysis?
        • Do tax cuts pay for themselves?
        • On what do economists agree and disagree about the effects of taxes on economic growth?
      • Economic Stimulus
        • What is the role of monetary policy in business cycles?
        • What are automatic stabilizers and how do they work?
        • What characteristics make fiscal stimulus most effective?
      • Distribution of Tax Burdens
        • How are federal taxes distributed?
        • Are federal taxes progressive?
        • How should progressivity be measured?
        • What is the difference between marginal and average tax rates?
        • What criticisms are levied against standard distributional analysis?
        • How should distributional tables be interpreted?
        • Who bears the burden of the corporate income tax?
        • Who bears the burden of federal excise taxes?
        • How do financing methods affect the distributional analyses of tax cuts?
      • Tax Expenditures
        • What are tax expenditures and how are they structured?
        • What is the tax expenditure budget?
        • Why are tax expenditures controversial?
        • What are the largest tax expenditures?
      • Tax Gap
        • What is the tax gap?
      • Tax Shelters
        • What is a tax shelter?
      • History of the Tax Code
        • What did the 2008–10 Tax Stimulus Acts do?
        • What did the American Taxpayer Relief Act of 2012 do?
    • Key Elements of the U.S. Tax System
      • Individual Income Tax
        • What's the difference between tax deductions and tax credits?
        • How do phase outs of tax benefits affect taxpayers?
        • How do the standard deduction and itemized deductions compare?
      • Capital Gains and Dividends
        • How are capital gains taxed?
        • What is the effect of a lower tax rate for capital gains?
        • How might the taxation of capital gains be improved?
        • What is carried interest, and how should it be taxed?
      • AMT
        • What is the AMT?
        • Who pays the AMT?
        • How much revenue does the AMT raise?
        • Did the American Taxpayer Relief Act of 2012 fix the AMT?
        • Should the AMT replace the regular income tax?
        • How might we improve the AMT?
      • Taxes and the Family
        • What is the personal exemption?
        • Has the personal exemption kept up with prices and incomes?
        • What is the child tax credit (CTC)?
        • What is the adoption tax credit?
        • What is the earned income tax credit (EITC)?
        • How does the tax system subsidize child care expenses?
        • What tax benefits exist for K-12 education?
        • What tax incentives exist to help families save for college?
        • What tax incentives exist to help families pay for college?
        • What are marriage penalties and bonuses?
      • Taxes and the Poor
        • How does the federal tax system affect low-income households?
        • What is the difference between refundable and nonrefundable credits?
        • Can poor families benefit from the child tax credit?
        • Why do low-income families use tax preparers?
        • How does the EITC affect poor families?
        • What are error rates for refundable credits and what causes them?
        • How do IRS audits affect low-income families?
      • Taxes and Retirement Saving
        • What kinds of tax-favored retirement accounts are there?
        • How large are the tax expenditures for retirement saving?
        • What are defined-benefit retirement plans?
        • Who uses tax-favored retirement savings accounts?
        • What are defined-contribution retirement plans?
        • What types of nonemployer-sponsored retirement accounts are available?
        • What are Roth individual retirement accounts?
        • How does tax-favored retirement saving affect national saving?
        • What’s the difference between front-loaded and back-loaded retirement accounts?
        • What is an automatic 401(k)?
        • How might low- and middle-income households be encouraged to save?
        • What is the myRA
      • Taxes and Charitable Giving
        • How are charitable contributions treated?
        • What entities are tax-exempt as charitable activities?
        • Who benefits from the charitable deductions?
        • How could we improve incentives for charitable giving?
        • How large are individual income tax incentives for charitable giving?
        • How might tax reforms reduce incentives for charitable giving?
      • Taxes and Health Care
        • How much does the federal government spend on health care?
        • Who has health insurance coverage?
        • What tax provisions subsidize the cost of health care?
        • How does the tax exclusion for employer-sponsored health insurance work?
        • How does the employer-sponsored insurance exclusion affect health insurance coverage?
        • What are premium tax credits?
        • What is the Cadillac tax?
        • What tax changes did the Affordable Care Act make?
        • How do health savings accounts (HSAs) work?
        • How do flexible spending accounts (FSAs) for health care expenses work?
        • How do health reimbursement accounts (HRAs) work?
      • Taxes and Homeownership
        • What are the tax benefits of homeownership?
        • Do existing tax incentives increase homeownership?
      • Tax Complexity
        • Why are taxes so complicated?
        • How costly is complexity?
        • What are the benefits of simpler taxes?
        • What policy reforms could simplify the tax code?
      • Taxes and Education
        • What tax benefits exist for K–12 education?
        • What tax incentives exist to help families pay for college?
        • What tax incentives exist to help families save for college?
      • Wealth Transfer Taxes
        • How do the estate, gift, and generation-skipping transfer taxes work?
        • Who pays the estate tax?
        • How many people pay the estate tax?
        • What is the difference between carryover basis and a step-up in basis?
        • How could we reform the estate tax?
        • How should wealth be taxed?
        • What is an inheritance tax?
      • Payroll Taxes
        • What are the major federal payroll taxes, and how much money do they raise?
        • What is the unemployment insurance trust fund, and how is it financed?
        • What are the Social Security trust funds, and how are they financed?
        • Are the Social Security trust funds real?
        • What is the Medicare trust fund, and how is it financed?
      • Excise Taxes
        • What are the major federal excise taxes, and how much money do they raise?
        • What is the Highway Trust Fund, and how is it financed?
      • Taxes and Energy
        • What tax incentives encourage energy production from fossil fuels?
      • Taxes and the Environment
        • What is a carbon tax?
      • Business Taxes
        • How does the corporate income tax work?
        • What are flow-through enterprises and how are they taxed?
        • Is corporate income double-taxed?
      • Tax Incentives for Economic Development
        • What is the new markets tax credit, and how does it work?
      • Taxes and Multinational Corporations
        • How does the current system of international taxation work?
        • What are the consequences of the US International Tax System?
        • How does the tax system affect US competitiveness?
        • How would formulary apportionment work?
        • What are inversions, and why do they happen?
        • What are the options for reforming our international tax system?
    • How Could We Improve the Federal Tax System?
      • Incremental Tax Reform
        • What are ten ways to simplify the tax system?
        • How might low- and middle-income households be encouraged to save?
        • How might we improve the AMT?
        • What policy reforms could simplify the tax code?
        • How might the taxation of capital gains be improved?
        • How could we reform the estate tax?
        • How could we improve incentives for charitable giving?
        • What are the options for reforming our international tax system?
      • Comprehensive Tax Reform
        • What is comprehensive tax reform?
        • What are the major options for comprehensive tax reform?
      • Broad-Based Income Tax
        • What is it a broad-based income tax?
        • What would and would not be taxed under a broad-based income tax?
        • What would the tax rate be under a broad-based income tax?
      • National Retail Sales Tax
        • What is a national retail sales tax?
        • What would and would not be taxed under a national retail sales tax?
        • What would the tax rate be under a national retail sales tax?
        • What is the difference between a tax-exclusive and a tax-inclusive sales tax rate?
        • Who bears the burden of a national retail sales tax?
        • Would tax evasion and avoidance be a significant problem for a national retail sales tax?
        • What would be the effect of a national retail sales tax on economic growth?
        • What transition rules would be needed for a national retail sales tax?
        • Would a national retail sales tax simplify the tax code?
        • What has been the state and local experience with retail sales taxes?
        • What is the experience of other countries with national retail sales taxes?
        • Why wouldn't the rate for a national retail sales tax be 23 percent?
        • What did the President’s Advisory Panel on Tax Reform say about the national retail sales tax?
      • Value Added Tax (VAT)
        • What is a VAT?
        • How would a VAT be collected?
        • What would be taxed under a VAT?
        • What would the rate be under a VAT?
        • What is the difference between zero rating and exempting a good in the VAT?
        • Who would bear the burden of a VAT?
        • Is the VAT a money machine?
        • How would small businesses be treated under a VAT?
        • What is the Canadian experience with a VAT
        • Why is the VAT administratively superior to a retail sales tax?
        • What is the history of a VAT?
        • How are different consumption taxes related?
      • Other Comprehensive Tax Reforms
        • What is the flat tax?
        • What is the X-tax?
      • Recent Comprehensive Tax Reform Proposals
        • Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System, Report of the President’s Advisory Panel on Federal Tax Reform, November 2005
        • The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform, December 2010
        • Debt Reduction Task Force, Restoring America's Future, Bipartisan Policy Center, November 2010
        • The Tax Reform Act of 2014: Fixing Our Broken Tax Code So That It Works for American Families and Job Creators, House Ways and Means Committee
        • The Graetz Competitive Tax Plan: Update for 2015
      • Return-Free Tax Filing
        • What is it return-free tax filing and how would it work?
        • What are the benefits of return-free tax filing?
        • What are the drawbacks of return-free tax filing?
        • How would the tax system need to change with return-free tax filing?
        • Who would qualify for return-free tax filing?
        • Would return-free tax filing raise taxes?
        • What was the experience in California with return-free tax filing?
        • What other countries use return-free tax filing?
    • State (and Local) Taxes
      • State and Local Revenues
        • What are the sources of revenue for state governments?
        • What are the sources of revenue for local governments?
      • Specific State and Local Taxes
        • How do state and local individual income taxes work?
        • How do state and local sales taxes work?
        • How do state and local property taxes work?
        • How do state and local corporate income taxes work?
        • How do state estate and inheritances taxes work?
        • How do state earned income tax credits work?
        • How do state and local severance taxes work?
      • Fiscal Federalism and Fiscal Institutions
        • How does the deduction for state and local taxes work?
        • What are municipal bonds and how are they used?
        • What types of federal grants are made to state and local governments and how do they work?
        • What are state rainy day funds, and how do they work?
        • What are tax and expenditure limits?

What’s the difference between front-loaded and back-loaded retirement accounts?

Taxes and Retirement Saving

<9/12>
Individual Taxes
Q.

What’s the difference between front-loaded and back-loaded retirement accounts?

A.

Your choice: pay the IRS now or pay them later.

Broadly speaking, there are two types of tax-favored retirement accounts: “front-loaded” accounts, such as traditional IRAs and 401(k)s, and “back-loaded” accounts, such as Roth IRAs. With front-loaded accounts, contributions are tax-deductible but withdrawals are taxed. These accounts are also called EET accounts (the contribution is exempt from taxation, the accrual of returns is exempt from taxation, the withdrawal is taxed). In back-loaded accounts, contributions are not tax-deductible but accruals and withdrawals are tax-free. These accounts are also called TEE accounts (contributions taxed, accruals exempt, withdrawals exempt). In both types of accounts, investment returns on assets kept within the account (accruals) are untaxed.

Which is a better deal? That depends on the difference between individuals’ tax rates during their working years and during retirement. Individuals with high tax rates during their working years and lower rates during retirement benefit more from front-loaded accounts, since the original contributions are deducted against high tax rates and withdrawals are taxed at lower rates. Someone who expects to be in a higher bracket in retirement would benefit more from a back-loaded account.

The example in Table 1 shows that if tax rates during working years and retirement are the same, front- and back-loaded accounts yield the same result.

Consider a front-loaded account first. Say an individual faces a 25 percent tax rate when making both contributions and withdrawals, makes a before-tax contribution of $2,000, earns 5 percent per year, and withdraws all funds after 10 years. In a front-loaded account, the individual will be able to contribute the full $2,000. The account will accumulate interest, and after 10 years the balance will be $3258. Upon withdrawal, the individual will pay $814 in taxes, leaving net retirement assets of $2,443. With a back-loaded account, an individual pays a 25 percent tax on $2,000 in income, leaving $1,500 to contribute to the account. With the same 5 percent return, the balance will grow to $2,443. Since no taxes will be paid on withdrawal, after-tax proceeds are $2,443, which is the same as in the front-loaded example.

Table 1 - Front and Back Loaded Savings Accounts with Constant Tax Rate: 2015

Now check out the example in Table 2, the tax rate decreases from 25 percent during working years to 20 percent during retirement. Here, the front-loaded account will accrue $163 more than the back-loaded account, since taxes are imposed upon withdrawal, when rates are lower. Of course, the conclusion is reversed if the tax rate is higher during retirement than during working years.

Table 2 - Front and Back Loaded Accounts with Lower Tax Rate at Retirement

That’s not quite the end of the story, though. If the two accounts have the same contribution limit, an individual can shelter more savings in a back-loaded account than in a front-loaded account. For example, if an individual facing a 25 percent marginal income tax rate contributes $2,000 to a front-loaded account, he or she is really contributing $1,500 and $500 of government funds because of the tax deduction. When the funds are withdrawn, the government reclaims its share of the principal contribution, plus taxes on interest earned (table 3). In a back-loaded account, however, taxes are paid on the initial contribution and interest can be withdrawn tax-free. Note the distinction here. The value of the tax shelter per dollar saved is the same with either account. However, if the nominal contribution limits are identical, a determined saver can sock away more with a back-loaded account.

Table 3 - Tax Savings in Front and Back Loaded Savings Accounts with Constant Tax Rate
Further Reading

Bell, Elizabeth, Adam Carasso, and C. Eugene Steuerle. 2004. “Retirement Saving Incentives and Personal Saving.“ Tax Notes 105:13. Washington, DC: Urban-Brookings Tax Policy Center.

Beshears, John, James J. Choi, David Laibson, and Brigitte C. Madrian. 2014. “Does Front-Loading Taxation Increase Savings? Evidence from Roth 401(k) Introductions.” NBER working paper 20738. Cambridge, MA: National Bureau of Economic Research.

Burman, Leonard E., William G. Gale, and David Weiner. 2001. “The Taxation of Retirement Saving: Choosing Between Front-Loaded and Back-Loaded Options.” National Tax Journal 54: 689–702.

Individual Taxes
Retirement
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