The Policy Impacts Library
MVPF Explained
- What is the MVPF?
  The MVPF methodology allows decision makers to compare the impacts of different types of policies and identify policies that have the highest returns on investment.
  START HERE
- Using the MVPF
  See stylised and real world examples that demonstrates the MVPF methodology in action.
  LEARN TO USE
- MVPF Lessons
  Explore the MVPF’s five key findings by analyzing over 100 US policy changes.
  SEE THE LESSONS
- Questions About the MVPF
  Explore answers to the most commonly asked questions about the MVPF and its application to policy analysis.
  VIEW THE FAQS

IRA Early Withdrawal Penalty

Introduction

Goda, Jones, and Ramnath (2022) calculate the MVPF of a penalty holiday on early withdrawals from individual Retirement Accounts (IRAs). IRAs afford taxpayers a higher return on savings through a lack of taxation on returns and the deferral of taxation on earnings until the saving are withdrawn but also impose a 10 percent penalty on most withdrawals before age 59.5. The paper uses administrative tax data and exploits variation in exposure to a one-year penalty holiday driven by date of birth to examine withdrawal behavior in a short window before and after the age when the penalty is lifted. They find a 3-3.5x increase in withdrawals relative to the baseline level after the penalty’s expiration, which declines to 2x the baseline after one month.

MVPF = 1.5

Net Cost

The primary cost to the government from a penalty holiday is the value of forgone penalties on early withdrawal less the additional tax revenue from the marginal increase in average withdrawals due to the penalty holiday.

Withdrawal penalties: Forgone penalties on early withdrawal is calculated as the penalty rate (10%) applied to the share of dollars that would have been subject to the penalty which is $0.1 per $1 withdrawn.
Tax revenue: Since the authors find a marginal increase in withdrawals with a penalty holiday, these withdrawals represent a reduction in government-subsidized returns through an IRA, and thus a marginal increase in tax revenue. This amount is equal to the present discounted value of income tax on the returns that would have been earned if the funds would have been held in an IRA which is $0.03 per $1 withdrawn.

The net cost is therefore $0.1 – $0.03 = $0.07 per $1 withdrawn.

$0.1 Net Cost

Willingness to Pay

For the duration of the penalty holiday, the daily average of withdrawals that would have been made in the absence of the penalty holiday is referred to as the inframarginal withdrawals. Willingness to pay is the value of avoided penalties or the penalty rate (10%) applied to the share of inframarginal withdrawals that would have been subject to the penalty. The willingness to pay is therefore $0.1 per $1 withdrawn.

$0.1 WTP

MVPF Summary

The MVPF of a 1-year penalty holiday occurring 5 years earlier than age 59.5, is then the ratio of the willingness to pay to the total cost US$0.10/US$0.07 = 1.47.

The authors note that if the one-year holiday occurs 10 years earlier than age 59.5, the MVPF becomes 3.41.

1.5 MVPF

References

Gopi Shah Goda, Damon Jones, and Shanthi Ramnath (2022). “Temporary and Permanent Effects of Withdrawal Penalties on Retirement Savings Accounts.” Journal of Public Economics, 215: 104734. https://doi.org/10.1016/j.jpubeco.2022.104734

Policy Features

Category: Social Insurance
Sub-Category: Retirement
Beneficiary Type(s): Adults
Average Income: 120000
Country of Implementation: United States
Empirical Method: Difference in Differences
Research Type: Primary
Peer Reviewed: Yes
MVPF Publication Link: www.sciencedirect.com/science/article/pii/S0047272722001360