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Consumption, investment and life insurance under different tax regimes

Published online by Cambridge University Press:  05 December 2012

Kenneth Bruhn*
Affiliation:
SEB Pension, Denmark and University of Copenhagen, Denmark
*
*Correspondence to: Kenneth Bruhn, SEB Pension, Postboks 100, DK-0900 Copenhagen C, Denmark or Kenneth Bruhn, Department of Mathematical Sciences, University of Copenhagen, Universitetsparken 5, DK-2100 Copenhagen, Denmark. E-mail: kbx@sebpension.dk or bruhn@math.ku.dk

Abstract

We study the effects of introducing taxation in classical continuous-time optimization problems with utility from consumption, bequest and retirement savings. Inspired by actual tax favoured retirement savings programs, we formulate and solve the optimization problem for various tax regimes, and compare tax effects on consumption/savings contributions, investment and purchase of life insurance under the regimes. The optimization problems have analytical solutions, which allow for easy comparison of tax effects under the different regimes. To substantiate the results we also present a numerical analysis of the results based on realistic parameter values and regimes. Based on American and Danish tax regimes we estimate the values of existing retirement saving favouring to be 1 – 2 percent of lifetime income.

Type
Papers
Copyright
Copyright © Institute and Faculty of Actuaries 2012 

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