Non-take-up of Tax-favored Savings Plans: Are Household Portfolios Optimal?

R.J.M. Alessie, Stefan Hochguertel, Arthur van Soest

Research output: Working paper / PreprintWorking paperProfessional

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Since the early nineties, the Dutch tax system allows for a tax-favored form of risk free savings through employer-sponsored savings plans (ESSPs). Under some conditions and up to a certain amount, the contributions to this plan are tax-deductible, and the returns as well as the withdrawals are tax-free. This makes these plans extremely attractive, with real after-tax returns by far exceeding the returns to other financial assets such as risk free saving accounts or stocks and bonds. It suggests that those who have access to this type of savings should participate in them, provided they have some financial wealth that they can allocate to their own choice. Moreover, unless liquid financial wealth is too small, each household should hold the maximum amount to which the tax incentives apply. In this paper, we analyze household data on participation in ESSPs. For those who have access to the asset, we investigate the relationship between the ownership decision, the amount held, substitution of other savings, and background characteristics. We find that people who are likely to face binding liquidity constraints less often buy ESSPs and, if they buy them, more often use them as a substitute for other savings. Regular smokers often do not hold ESSPs, suggesting that some people in this group do not compose their portfolios optimally. The results question the assumption of rational financial decision making, which is typically maintained in theoretical as well as empirical work on savings and portfolio choice.
Original languageEnglish
Place of PublicationAmsterdam
PublisherTinbergen Instituut
Publication statusPublished - 2002

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