An Analysis of the Rate of Return Effect of the Income Tax Deduction on the Personal Pensions

Yosup Chung

Journal of Insurance and Finance

2006, 17(2), pp.41-60
Publisher : Korea Insurance Research Institute
Research Area : Business Management

Yosup Chung ¹

¹ 한양대학교

ABSTRACT

The Government introduced the personal pension(PP) to induce a voluntary old-age income protection through the benefit of income tax deduction. Recently the lower rate of return(ROR) on the PP funds has become a big problem. But the problem may not be serious if the ROR effect of the income tax deduction on PPs can sufficiently recoup the lower ROR compared to that of similar financial products. In order to examine the ROR effect this study computed the average annual rates of return over the period of 10 and 20 years by making the cumulative sum of the 10 and 20 years interest-adjusted after-tax savings equal the simple sum of 10 and 20 years savings. The result shows two things. One is that the ROR effect on both the old and the new PP becomes larger as the marginal tax rate increases and the ROR effect of the 20-year savings period becomes almost half that of the 10-year savings period. The other is that the ROR effect is unexpectedly lower compared to the decreased tax amount on the savings on the PPs. Especially with respect to the old PP the ROR effect is very low except the high income tax bracket and the income tax deduction effect on the savings is ignorable. With respect to the new PP the ROR effect is more favorable to the higher income tax bracket than the lower income tax bracket. This result indicates that the current tax system on the PPs does not operate as an incentive to provide voluntary old-age income protection for the lower income tax bracket, so the system should be modified to provide all the PP participants with at least the same ROR effect.
KEYWORDS

personal pension , retirement income protection , income tax deduction , individual retirement annuity , marginal tax rate
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