Childcare & Employment Outcomes

  • Recent research likely understates the impact of children and lack of childcare on the economic recovery.
  • Many people with children may be underemployed and hours worked should be a key economic variable in a study of the impact of children on employment outcomes.
  • The impact of children and childcare on employment outcomes is concentrated on the part of the workforce that is of child-rearing age.  An analysis including people who are older and retiring will understate the impact of childcare on employment outcomes.
  • Additional research should consider multivariate models based on repeated cross sections and on longitudinal datasets.  The research should consider multiple existence of children definitions and educational attainment groups.

In a recent article, Jason Furman and coauthors argue that lack of childcare had only a small impact on the U.S. jobs recovery at the end of the COVID pandemic.    

Furman’s focus is on the change in the employed to population ratio for people with children under 13 and for people with no children over 13.  He finds a small decrease in labor force participation for women without a bachelor’s degree but no impact for any other group.

The research paper is narrowly focused on labor force participation and on a single definition of households with children.   Several additional tests are needed.

  • Many people without childcare are employed part time and would like to work additional hours.  It would be useful to examine how the pandemic impacted hours worked and underemployment for people with and without small children. My hypothesis is the existence of children of certain ages has a larger impact on underemployment than on labor force participation or unemployment.
  • The article does not document a pre-pandemic baseline on the impact of children and childcare on employment patterns.  It is likely that in normal times many people with children were already out of or marginally attached to the workforce.
  • Furman and coauthors consider only one classification of people with children — at least one child under 13.  Other existence of children variables including a child not yet in school, a school-age child, and multiple children in certain age groups should be considered.     
  • Furman and coauthors consider the impact of two education groups – no bachelor’s degree and bachelors or above on the impact of childcare on labor market outcomes.  It would be useful to consider three groups – less than bachelor’s degree, bachelor’s degree, and above bachelor’s degree.   I suspect this partition will show a significant impact of children on labor force outcomes for the large cohort of people ending their educational career with a bachelor’s degree.  Additional education beyond a four-year degree may reduce the impact of children on labor force outcomes.
  • The bivariate results presented by Furman and coauthors can be misleading because of omitted variables.   The bivariate framework does not allow for consideration of multiple child-existence variables or multiple education groups.  (See two comments above.). The bivariate framework also does not account for the impact of age on workforce outcomes and the interaction of an age and children on work outcomes.  
  • An analysis of the population in peak working years age 26 to 50 is likely to show a larger impact than an analysis of the entire population.  Older workers who are retiring may be out of the workforce regardless of whether they have children.  Furman’s finding that the impact of children on employment outcomes is small may be the result of the existence of a large number of older workers who are leaving the workforce.  The pertinent population for this question is workers of child-rearing age only.
  • The speed of the recovery and the impact of childcare on the labor market is likely to differ across industries.  Labor shortages have been most pronounced in restaurant and hospitality industry.  It would be useful to determine if the impact of childcare on employment and the labor market recovery is larger in some industries than other industries, especially since certain industries have a more pronounced labor shortage and are more highly dependent on female workers with young children.
  • The CPS can be used to track individuals over a period of time.  It would be highly useful to use longitudinal CPS data to compare month to month changes in labor market outcomes – fully employed, unemployed, underemployed, non-participant, from month to month.

Concluding Thoughts:  The analysis by Furman and coauthors likely substantially understates the impact of childcare on the economic recovery.  Much more analysis on this topic is needed.

Jason Furman, Kearney, M., and Powell, W. How much have childcare challenges slowed the US jobs market recovery.

Julia A. Rivera Drew, Flood, S, and Warren J.R. Making Full Use of the Longitudinal Design of the Current Population Survey:  Methods for Linking Records Across 16 Months


Conventional vs Roth Retirement Accounts

Some Tips on Saving and Distribution Strategies

  • Distributions from Roth retirement accounts are not subject to federal income tax, are often not subject to state income taxes and reduce the amount of Social Security benefits subject to tax.
  • People in low marginal tax brackets should choose to contribute to a Roth rather than a conventional plan and should covert conventional accounts to Roth accounts.
  • The conversion of conventional to Roth often requires workers roll over 401(k) plans to IRAs.
  • Non-deductible contributions to traditional IRAs can be converted to a Roth IRA without paying tax. 

Introduction:   Workers today have a choice between saving for retirement through a conventional or a Roth retirement. Both conventional and Roth retirement accounts allow investors to defer tax on gains from their account until funds are disbursed.   However, there are significant differences between the two types of retirement plans.

  • Contributions to most conventional retirement plans are made on a pre-tax basis and are not taxed during the year the contribution is made.  Contributions to Roth accounts are after-tax and fully taxed in the year the contribution is made.
  • Funds disbursed from the conventional account are fully taxed when disbursed. Funds disbursed from the Roth account are untaxed after age 59 ½.  
  • Funds distributed from a conventional retirement plan are part of adjusted gross income (AGI) and their inclusion in AGI can increase the portion of Social Security benefits subject to income tax.   Funds distributed from a Roth IRA are not included in AGI and do not result in an increase in Social Security benefits subject to income tax.
  • All funds disbursed from a conventional retirement account prior to age 59 ½ are subject both to income tax and a 10 percent penalty.   Withdrawals of contributions from a Roth account prior to age 59 ½ are not subject to penalty or tax because the funds were fully taxed at the time of the contribution.  Early withdrawals of investment income from the Roth account are subject to tax and penalty.

Most workers fund their retirement plan through a 401(k) or similar defined contribution plan at work.   Workers at firms that do not have access to a retirement plan through their employer may fund their retirement through an Individual Retirement Account (IRA).  Firms can offer either a conventional or Roth 401(K) plan and individuals can choose between a conventional or Roth IRA.  Some workers choose to invest in both their firm-sponsored retirement plan and an IRA. 

The conventional vs Roth choice for people who do not have access to an employer-sponsored plan depends primarily on potential tax and financial situations during working years compared to potential tax and financial situations in retirement.   

The conventional vs Roth choice for people with access to a firm-sponsored retirement plan is more complicated.    The choice depends on the characteristics (fees and employer match) of the firm-sponsored retirement plan and the availability of a Roth option.  In some cases, it makes sense for a worker to maximize the employer match available from the firm-sponsored retirement plan and invest additional funds through an IRA.

This memo provides several tips on how to save through retirement plans during working years and how to distribute funds from retirement plans during retirement.

Tips on the Conventional vs Roth Decision

Tip Number One – Tax avoidance during working years should not dictate the choice between conventional and Roth contributions. A smaller Roth contribution is comparable to a larger conventional contribution.  Whether a person with a smaller Roth balance is better or worse off than a person with a larger conventional balance depends on potential savings in retirement. 

Since contributions to conventional retirement accounts are pre-tax and contributions to Roth accounts are after-tax, people can afford to contribute more to conventional account than a Roth account.  

  • A person in the 10 percent tax bracket who contributes $4,000 to a conventional account would forego the same amount of current resources by contributing $3,600 to a Roth account and paying $400 in tax.
  • A person in the 32 percent tax bracket making a $4,000 contribution to a conventional retirement account would forego the same level of current resources by contributing $2,720 contribution to a Roth and paying $1,280 in tax.   

Naturally, a person who contributes pre-tax dollars into a conventional retirement account will have a larger balance than a person who contributes after-tax dollars to a Roth.  

Estimates of the differences in conventional retirement account balances were calculated assuming lifetime marginal tax rates of 10 percent and 32 percent.   The assumptions behind the estimates are equal after-tax conventional and Roth payments, a pre-tax conventional payment of $4,000, 30 years of work, 26 payments per year and a rate of return of 8 percent per year.  

  • At the 10 percent tax rate, the wealth at retirement is $499,132 for the conventional account and $449,219 for the Roth account.
  • At the 32 percent tax rate, the wealth at retirement is still $499,132 for the conventional account but is now $339,410 for the Roth account.

The larger magnitude of wealth in the conventional account does NOT mean people are better off with Roth accounts than conventional accounts because Roth disbursements are not subject to tax after age 59 ½ and their exclusion from AGI reduces Social Security benefits subject to income tax.

Tip Number Two: People in low marginal tax rates should choose a Roth account over a conventional account.

Most people start their career at a low marginal tax rate and move to a higher bracket when their career advances.  Note that at low-marginal tax rates the difference in contributions between conventional and Roth plans is relatively small.  People should contribute to a Roth rather than a conventional plan when their marginal tax rate is low and should contribute to a conventional plan rather than a Roth when their marginal tax rate is high.

The choice between conventional and Roth contributions may involve a reduction in the amount contributed.  As noted above, a $4,000 contribution to a conventional retirement plan is equivalent to a $3,600 contribution to a Roth account for a person in the 10 percent tax bracket.   

Tip Number Three:   Workers need to consider relative advantages of firm-sponsored retirement plans and individual retirement accounts.   In some cases, the choice of an individual retirement account leads to an increase in Roth investments.

Most people routinely enroll in the firm’s retirement plan.  Some firms do not offer a Roth 401(k) plan.  Workers at firms that do not have access to a Roth 401(k) plan may be able to contribute to a Roth IRA.

The ability to contribute to a Roth IRA is phased out for people with income of $125,000 for individual filers and income of $197,000 for married joint return filers.  Higher income filers are often unable to invest through a Roth IRA and must instead rely on the firm-sponsored plan.

All people can contribute to a traditional IRA as well as their employer-sponsored retirement, however, the tax deduction associated with the contribution to traditional IRAs is phased out for people at work.  The non-deductible IRA can be converted to a Roth IRA through a process called a backdoor IRA, discussed further in Tip Number Six below. 

Workers at firms that offer a 401(k) plan but impose high fees or do not match employee contributions might be better off with an IRA than the firm-sponsored plan. The most common rule is for employers to match 50 percent of contributions up to 6 percent of income.  A person at a firm with this matching benefit could contribute 6 percent of income to a 401(k) plan and then save additional funds in a Roth IRA if the person’s income is below the phase out limit. 

Tip Number Four:   Conversion of conventional retirement accounts to Roth IRAs can substantially increase after-tax retirement savings.  Tax considerations determine the best time to implement the IRA conversion.  It is possible for a person in retirement with a zero or low marginal tax rate because of Roth IRA disbursements to convert additional funds to Roth IRAs at little or no cost.

Some people with assets in a conventional retirement plan may be able to convert the assets to a Roth retirement plan.  The ability to make this transfer varies based on several circumstances described below.

  • Some, but not all, firms with both conventional and Roth 401(k) plans will allow employees to convert their conventional 401(k) plan to a Roth 401(k) plan.   
  • Employees who leave a firm can roll over their 401(k) assets to an IRA.   This action is highly desirable if the firm 401(k) plan has high fees or if the investment opportunities at the firm’s retirement plan are highly limited.  The conventional IRA can then be converted to a Roth IRA.
  • Some firms allow employees over the age of 55 to make an in-service rollover from the firm’s retirement to an IRA.   The conventional IRA can then be converted to a Roth IRA.
  • A person with a conventional IRA can convert to a Roth IRA at any time.  There are, however, limits on disbursements from the newly converted Roth IRA for five years after the conversion.

The cost of the conversion is the additional tax from the increase in adjusted gross income.   The payment for the conversion should come from funds outside the retirement plan to avoid a 10 percent penalty.  Some analysts argue the payment of taxes from sources outside the retirement plan is preferrable to allow greater tax deferral inside the retirement plan.  However, some investments outside retirement plans, like Treasury I-Bonds and EE-Bonds, also defer tax.   

The most desirable time to make a conversion from a conventional to Roth account is when the taxpayer is in a low marginal tax bracket.   This will occur when a worker becomes unemployed, takes a sabbatical, returns to school, has low taxes due to some other life event, or has low taxes in retirement.   

A person in retirement who is paying low or zero taxes because she is disbursing Roth assets can covert additional conventional assets at an extremely low cost.  

Tip Number Five:   Disbursements from Roth IRAs can substantially lower the amount of Social Security benefits subject to income tax.  People who delay claiming Social Security benefits should delay disbursements from Roth accounts and use funds from conventional accounts until they claim Social Security benefits.

Conventional 401(k) disbursements are included in Adjusted Gross Income (AGI).  Disbursements from Roth accounts are not included in AGI.  The portion of Social Security benefits subject to federal income tax is based on a concept called combined income, which is reduced by disbursements from Roth IRAs which are not include.

The reduction in AGI and potential taxes can be considerable.

  • A person with a $25,000 Social Security benefit and a $30,000 distribution from a conventional retirement account would, based on my back of the envelope calculation, have an AGI of $44,850.  (The conventional retirement account plan distribution is fully taxed along with $19,850 of Social Security benefits. 50 percent of benefits between $30,000 and $34,000 plus 85 percent s of the remaining $21,000.) A person filing an individual return, with a $25,000 Social Security benefit and a $30,000 Roth disbursement would have an AGI of $0.  (The Roth distribution is not taxed and all Social Security benefits below $25,000 are untaxed.)

The person in this example paying $0 in tax because of Roth will claim the standard deduction of $12,400.   If the person has no additional income, she could convert an additional $12,400 from a conventional to a Roth account and still pay $0 in tax.

Larger Roth disbursement lower the taxpayer’s marginal tax rate and lower the cost of additional conversions from conventional to Roth accounts.  A married couple disbursing $80,000 from a Roth instead of a conventional account, with no additional income would likely be in the 0% tax bracket and be able to convert $24,800 from a conventional to a Roth account at zero cost.

The total savings from the use of Roth is the sum of the direct savings from distributions from the Roth account not being taxed, the lower marginal tax rate from the exclusion of Roth distributions from AGI and the reduction in tax on Social Security benefits from the exclusion of Roth distributions from AGI.   The benefits from the use of Roth tend to be larger when the person is claiming Social Security benefits because of this third component.

Hence, a general rule of thumb is, distribute conventional assets when you are not claiming Social Security benefits and distribute assets from the Roth account when you are claiming Social Security benefits.

Tip Number Six:  Funds in a Non-Traditional IRA that were not deducted from income in the year the contribution was made can be converted to a Roth account without paying additional tax.

All people even those with high income or access to a firm-sponsored retirement plan can contribute to a non-deductible IRA.  Funds in the non-deductible IRA can be converted to a Roth with the investor only paying tax on investment returns because the investor has already paid tax on the contribution to the non-deductible IRA.   

The process of contributing to a non-deductible IRA and immediately converting all funds to a Roth account is called a backdoor IRA.   It basically allows higher-income people who are not eligible to directly contribute to a Roth account to circumvent the income limits on Roth accounts.   This useful tutorial shows how to establish a backdoor IRA.

Tip Number Seven:  People withdrawing funds from retirement accounts prior to age 59 ½ are likely to be better off with a Roth than a conventional plan.

Research indicates that distributions from 401(k) plans prior to retirement are widespread. One study by E-trade indicates that 60 percent of millennials have withdrawn funds from their 401(k) plan.   A study by the Boston Research Group found that 22 percent of people switching jobs routinely take funds out of their 401(k) plan and spend it.   My own recent research has indicated that people tapping 401(k) plans tend to have poor credit ratings and high levels of other consumer loans.  The use of Roth rather than conventional accounts may allow some people to avoid unanticipated taxes and penalties.

A person who is likely to withdraw funds prior to retirement will likely be better off having made contributions to a Roth account than a conventional account. Distributions from conventional accounts prior to retirement are fully taxed at ordinary income tax rates and are subject to a 10 percent penalty.   The initial contribution to a Roth account is not subject to tax or penalty.  

Tip Number Eight:  People who inherit a Roth IRA will be substantially better off than people who inherit a conventional IRA.

As explained in this CNBC article,  the 2019 Secure Act changed rules governing distributions from inherited IRAs and 401(k) plans.   The new rules require people, with the exception of spouses and minors, who inherit a 401(k) plan to take disbursements within a 10-year period. Funds not distributed by year 10 are subject to a 50 percent penalty.

Funds distributed from the Roth retirement account during the 10-year period are untaxed.  Funds distributed from a conventional account are taxed as ordinary income.   The additional tax for the person inheriting an IRA during peak working years can be considerable.

Tip Number Nine:  State tax considerations also impact investments in Roth IRAs.

The decision to use a Roth rather than a conventional retirement plan is more attractive in States with an income tax, especially if the state has a high marginal tax rate and states that tax Social Security benefits.

Thirteen states tax Social Security benefits.  Most states follow federal rules and do not tax Roth distributions and do not count Roth distributions towards the taxation of Social Security benefits.  However, it is permissible for states to differ from federal rules. 

The cost of the conversion from a conventional account to a Roth account is also impacted by state income taxes as discussed in this CNBC article.  People planning to move from a state with an income tax and a high marginal tax rate to a state with either no income tax or a low marginal tax rate should delay conversions until they move.   People moving in the opposite direction might convert prior to the move.

Concluding Remarks:   Financial planners often stress the need to accumulate large retirement plan balances.  Retirement plan balances are generally much larger for people who use conventional retirement accounts than Roth accounts.  However, people saving primarily through Roth accounts often pay very little tax during retirement and a person with a medium sized Roth account may be substantially better off than a person with a larger conventional account.