Félix Domínguez-Barrero

Julio López-Laborda

Why do people invest in personal pension plans?

Keywords: pension plans, tax planning, retirement purposes Pension plans, retirement purposes, tax planning Pension plans, retirement purposes, tax planning Pension plans, retirement purposes, tax planning

The aim of this paper is to identify the variables affecting the decision to make contributions to personal pension plans and the amount of such contributions. For this purpose, we specify and estimate a Tobit model for a sample based on the 1995 Personal Income Taxpayers Panel prepared by the Institute of Fiscal Studies (Spanish Ministry of Economy and Finance) formed by 3,041 taxpayers, of whom 358 made contributions to pension plans. Our results suggest that individuals decide to invest in pension plans on complex grounds combining the wish to benefit from tax savings and to ensure they will receive supplementary income upon retirement.

Introduction

The tax treatment of pension plans is currently a matter of some debate in Spain. The government's position is that the favourable tax treatment accorded to such instruments provides an incentive for the better off to invest, while the lower and middle income groups hardly make any use of them. Thus, investment in pension plans is more a matter of tax planning than financial prudence in anticipation of retirement. This paper seeks to make a contribution to this debate, and to this end we shall use information provided in 1995 personal income tax returns to investigate the reasons underlying the two decisions made by the holders of pension plans, first to set up a plan and then to make contributions for a given amount.

The Spanish Pension Plans and Funds Regulation Act, 1987(Law 8/June 8, 1987) regulated pension plans, defined as voluntary prudential institutions providing benefits supplementing those of the public social security system. The Act refers to three types of pension plan depending on the person who offers them. These are "occupational schemes" in which the sponsor of the pension plan is an organisation, corporation, company or firm (that is, an employer) and the members are employees; "associated schemes" sponsored by associations or trade unions for their members or affiliates; and "personal schemes" sponsored by one or more financial entities and having private individuals as their members. In this paper, we shall focus on personal pension plans.

Pension plans may also be classified on the basis of the obligations provided for in the contract. Thus, "defined benefits plans" fix the amount of the final pension the beneficiaries will receive; "defined contributions plans" establish the amount of the contributions the sponsors and, where applicable, participants must make; and "mixed F o r P e e r R e v i e w 3 plans" simultaneously stipulate eventual benefits and the amount of contributions. While occupational and associated pension plans may fall into any of these three categories, personal pension plans will always be defined contributions schemes.

Pension plans have received a highly favourable tax treatment since they were first regulated in 1987, and as a result they now represent a growing part of the financial assets held by individuals.

The rest of this paper is structured as follows. In Section 2, we outline the tax regime applicable to pension plans in Spain since 1987. The data presented are expressed in terms of the internal rate of return of pension plans in the three periods [1987][1988][1989][1990][1991][1992][1993][1994][1995][1996][1997][1998] and from 1999 onwards.

The applied model is set out and discussed in Section 3. In order to discover the factors explaining the decisions associated with investment in personal pension plans, we specify and estimate a Tobit model for a sample drawn from the 1995 Personal Income Taxpayers Panel prepared by the Institute of Fiscal Studies (Spanish Ministry of Economy and Finance). Our conclusion from this exercise is that the holders of personal pension plans are motivated both by reasons of financial prudence and tax savings.

Section 4 ends the paper with some final considerations.

The tax treatment of pension plans

In this section, we shall describe the tax treatment of pension plans and quantify their internal rate of return (IRR) since 1987. This analysis distinguishes between the three moments at which the tax treatment affects investment in pension plans, namely when contributions are made, during the accumulation of returns, and when the benefit 1 shows the expressions for the IRR of the pension plans in the three periods considered. The tax treatment of the plans is summarised in Table 2.

[TABLES 1 and 2 ABOUT HERE]

Contributions

The contributions made to pension plans are tax allowable within certain limits.

Initially, in the period 1987-1991, the contribution could be deducted from taxable income provided the amount of the deduction was less than 15 percent of the sum of net earnings from work and business activities (earned income) or 500,000 pesetas. The remaining contributions were eligible for a 15 percent tax credit up to a limit of 750,000 pesetas. In the early years, these limits were applied to each tax return, but this changed in 1989, when married people were allowed to file separate returns, and tax credits and allowances became applicable to each taxpayer included in the return.

There were two key changes to the tax treatment of contributions to pension plans in the ensuing years. Firstly, the 15 percent tax credit was removed (1992) and, secondly, the absolute and relative limits on the deduction from taxable income were raised.

Since 2003 the absolute deduction for people aged under 53 years has been € 8,000, with an additional € 1,250 for each additional year over the age of 52 to a maximum of € 24,250 for pension plan contributors aged over 65. Meanwhile, the relative limit on deductions was removed in 2002, and the maximum allowable contribution has since been 100 percent of taxable income excluding capital gains.

Based on this regulatory framework, let us initially assume an initial capital IC available for investment in a pension plan. The contribution made produces tax savings.

1 See Scholes et al.(2002). Given that the unit deduction will differ depending on whether it is applied to taxable income or tax liability, which shall denote each alternative by d q , where q takes the value 1 or 2, respectively, for deductions from taxable income or tax liability. If the contribution is deductible from taxable income, d 1 = t px , where t px is the marginal rate subject to the age x at which the taxpayer made the contribution. If it is deductible from tax liability, then d 2 = 0,15.

Hence, the net initial capital, NIC, will be equal to:

) 1 ( q d IC NIC = [1]

Accumulation

The returns generated by pension plans are not taxable during the accumulation period. In the first place, the pension plan holder does not pay any income tax on the returns generated, which are not imputed to him. Meanwhile, the pension fund itself, though subject to Corporate Income Tax, benefits from a zero tax rate. Thus, the fund is required to file a corporate income tax return, but only to recover amounts withheld at source. Finally, Net Wealth Tax is not levied on the investment, because the vested rights in the plan were not initially subject to the tax, and they are currently exempt.

Hence, the net rate of interest on the pension plan investment is:

i t i i s N = = ) 1 ( [2]
where i is the nominal gross rate, and t s the corporate tax rate. If x is the age of the individual making contributions to the pension plan, and j is her age upon retirement, the final capital accumulated will thus be:

x j x j N i IC i IC FC + = + = ) 1 ( ) 1 (
[3]

Benefits

When benefits are paid, the total amount is included in taxable income by way of earnings from labour. The way in which the tax base is established and the applicable tax rate calculated has changed over time.

As shown in Table 2, the benefits received from the plan are eligible for an allowance. This was initially 2 percent of the returns obtained and is currently 40 percent.

Between 1991 and 1998, the annualised returns (i.e. the quotient of taxable returns and the number of years in which they were generated) were taxed at the marginal tax rate.

The remainder returns were taxed at the average rate, because it would not be equitable to apply a progressive tax schedule to returns generated over a number of years. Since 1999, the taxable part of pension plan benefits have been taxed at the relevant marginal tax rate.

Let us call the equivalent tax rate applicable to benefits t e , and the taxable part of the final capital obtained g. The tax liability will now be:

FC g t T e P = [4]
And the net final capital will be:

) 1 ( ) 1 ( ) 1 ( g t i IC g t FC T FC NFC e x j e P + = = = [5]
The formula for IRR is:

F o r P e e r R e v i e w 7 1 1 . 1 ) 1 ( 1 1 1 + = = x j q e x j d t g i NIC NFC IRR [6]
The IRR of pension plans has grown continuously since 1987 thanks to the tax regime, which is more favourable than for any other savings instrument. As shown in Figure 1, these assets have gradually increased their share of the portfolios held by individuals to somewhat more than 6 percent at present. 2

[FIGURE 1 ABOUT HERE]

Income, age and pension plan investment

Let us now focus on the variables influencing the decision to invest in a personal pension plan. Based on the expression of IRR, we can predict the relationship between pension plan investment and the investor's income. Since the year considered in the present empirical study is 1995, we shall work with the IRR expression for the period 1992-1998, which is:

1 1 . 1 ) 1 ( 1 + = x j px e t t g i IRR [6']
In order to obtain the relationship between IRR and income levels, we first need to establish the relationship between the marginal tax rate at the time the contribution is made, t px , and the equivalent tax rate levied on the benefits, t e . As explained above, the latter is the weighted average of the average and marginal tax rates at the time the benefit is paid.

2 Figure 1 was constructed on the basis of the Financial Accounts of the Spanish Economy, prepared by the Bank of Spain. Exhaustive information concerning pension plans in Spain is available in Dirección General de Seguros y Fondos de Pensiones (2004) We may therefore make the general assumption that it will be related to the initial marginal tax rate in the following manner:

px e t k t = , 1 0 < < k [7]
Thus, the pension plan participant's income at the time the benefit is received, and hence the applicable tax rate, will be a given proportion of the income she received and the applicable tax rate applied while she was active. We may now calculate how IRR will vary when t px changes:

( ) ( )

0 1 1 1 1 ) ( 1 2 1 1 > + = px x j px e px t k g t t g x j i t IRR [8]
Accordingly, the IRR of pension plans rises in line with contributors' incomes and the applicable tax rates. We may therefore expect to find a positive relationship between income and pension plan contributions.

Let us look now at the incentive to invest in pension plans and age. The IRR of pension savings is of no use to us here, because investments of differing duration cannot be compared on this basis. Consequently, we shall calculate the net present value of the investment in the plan, assuming that the alternative investment is tax exempt.

Based on the net initial and final capital respectively given in [1] and [5], the net present value of a one euro investment in a pension plan would be:

) 1 ( ) 1 ( ) 1 ( ) 1 ( ) 1 ( k g t t g t t g t i NFC t NPV px e px e px x j px = = + = = + + = [9]
Hence, anybody investing in a personal pension plan obtains a subsidy per unit invested, which is the same at any age. This subsidy represents compensation for the

F o r P e e r R e v i e w
absence of liquidity inherent in pension plans. However, if we take into account that the loss of liquidity diminish as people grow older and the recovery of the investment draws nearer, we may conclude that the incentive to invest in pension plans is greater for older people.

Empirical evidence for personal pension plan investment decisions

In this section, we seek to answer the two questions forming the objective of this paper. What variables influence the decision to invest in a personal pension plan? And, what variables affect the amount individuals decide to contribute to their pension plans?

To answer these questions, we shall specify and estimate a Tobit model for a 1995 sample (the latest available) from the Institute of Fiscal Studies Personal Income Taxpayers Panel.

The sample is formed by 3,041 tax returns, of which 358 include contributions to personal pension plans.

Following Cabrer, Sancho, and Serrano (2001), the specification of the model is as follow 3 . The regressand Y i can take a value of zero or the value of the variable * i Y , known as the latent variable:

( ) ( ) + = > = i i i i i i i i u X Y X Y Y X Y 0 , / 0 0 , / * * [10]
In the first stage a Probit model is used to determine the probability that the variable * i Y will take a value of zero rather than a positive value. In the second stage, a real and positive value is assigned to the variable Y i after a positive value has been 3 See also, Wooldridge (2003).

i i i u X Y + = * [11]
where are the coefficients, X i the regressors, and u i is the error term, which is a random variable distributed based on normal N(0, 2 ).

In our model, the dependent variable is the amount of contributions made to pension plans. The explanatory variables are those usually considered in the literature 4 , to which have added some others that are specific to the reality of Spain. The variables used and the expected sign for each are shown in Table 3. Table 4, meanwhile, reflects the percentage of personal pension plan contributors for each variable, as well as the average contributions made. As the first row of this table shows, 11.77 percent of 1995 tax returns declare contributions to personal pension plans, the average amount of which was 150,564 pesetas. 5 The regressors considered were as follows:

Age. Based on the argument derived from expression [9], we may expect to find a positive relationship between age and the contributions made to pension plans. This variable has been included quadratically as well. Marital status. We have used a dummy variable with a value of zero for unmarried and one for married taxpayers. We opted to assign a positive sign to this variable, because we believe that prudential behaviour is more likely in the case of married people.

Income level. Based on expression

[8], we may expect a positive relationship between individuals' income levels (i.e. taxable income prior to tax allowance for contributions) and the amount of the contributions made to pension plans. For the same reason, we may assign a positive value to the variable marginal tax rate. In addition, higher earners will also have greater capacity for savings. The income variable has also been included quadratically.

Occupation. We have used dummy variables for the categories entrepreneurs, professionals and salaried employees. We consider that the first two categories are likely to make higher contributions than employees because their mandatory social security contributions are smaller. Also, we would expect professionals to make higher contributions because they are, in general, better educated and are likely to be more aware of the advantages of this saving instrument .

Year-end tax bill. The aim of this variable is to verify the hypothesis that people invests in pension plans with a view to reducing their year-end tax bill (i.e. the part of income tax not paid through withholdings at source), which is due upon the presentation of the income tax return. Thus, the higher the tax bill, the higher will be the pension plan contributions made.

Membership of occupational pension plans.

Our hypothesis is that membership of occupational pension schemes will encourage the participation on personal plans. We have employed a dummy variable with a value of one for taxpayers who are members of occupational schemes and zero for those who are not. In the case of the former, however, we expect the contributions made to fall as the employer's contribution rises. This variable has been assigned a negative sign. Prior year's contribution. We believe that the behaviour of people contributing to pension plans may be to some extent routine, with the result that they will continue to contribute a roughly similar amount each year after setting up the plan. Consequently, we have assigned a positive sign to this variable.

Mortgage repayments.

A person who is still repaying the mortgage on his home will have less spare cash to contribute to his pension plan. The higher these mortgage repayments are, the less the person will contribute to the plan.

Life insurance contributions.

Like pension plans, life insurance policies are prudential savings instruments, although they do not have the same characteristics. While pension plans receive a more favourable tax treatment, life insurance are more liquid. If pension plans and life insurance are substitute assets, we may expect that higher life insurance contributions will be associated with smaller contributions to pension plans. On the other hand, if they act as complementary assets (as table 4 would seem to indicate), this relationship will be the reverse. In short, we are unable to assign a positive or negative sign to this variable.

[TABLES 3 and 4 ABOUT HERE]

The relationship between investment in the home, pension plans and life insurance is clearly apparent in figures 2 and 3, which are constructed on the basis of the sample of tax returns used for the applied study of 1995. It may be observed in figure 2, that buying a house is the most important investment made by people in their lifetimes. However, Figure 3, which takes income levels into account, reflects sustained growth in average mortgage repayments along the income scale. This effect is particularly pronounced in the two upper deciles. There is also a slight rise in investment in pension plans and life insurance until the last two deciles, where average contributions increase sharply, especially in the case of pension plans.

[FIGURES 2 and 3 ABOUT HERE] Based on the above variables, we have specified three models which provide alternative explanations for the decision to invest in a personal pension plan. The first of these, which we shall call the "prudential model", is based on the hypothesis that individuals invest in pension plans basically to save against their retirement, perhaps as a supplement to other retirement funds obtained from sources such as the social security or life insurance. The explanatory variables in this model are age, marital status, occupation, membership of an occupational pension plan, employer's contributions, prior contributions, mortgage repayments and contributions to life insurance. The specification of the model is as follows:

) , , , , , , , , , , ( 1
INSURANCE MORTGAGE PRIORC EMPLOYERC ALP OCCUPATION SALARIED AL PROFESSION UR ENTREPRENE STATUS AGE C f PLAN = [12]
The second "tax planning model" refers to the hypothesis that the individual's main motivation is to obtain the tax benefits available to investors in pension plans. The Finally, the "general model" includes all of the exogenous variables and is based on the hypothesis that investment in pension plans can be explained both by prudential and tax planning concerns. The specification of the model is as follows:

) , , , , , , , , , , , , , ( 3
INSURANCE IMORTGAGE PRIORC EMPLOYERC ALP OCCUPATION TAXBILL MARGINALT SALARIED AL PROFESSION UR ENTREPRENE INCOME STATUS AGE C f PLAN = [14]
The heteroskedastically robust estimation of the models was performed using the Econometric Views (Eviews) application, version 3.1. Using the logarithm of the verisimilitude function and the Aikake, Schwarz and Hannan-Quinn criteria as the selection criteria, we chose the general model as the most adequate. The results of the estimation are shown in Table 5.

The variables found to be significant took the expected signs. In the first place, the amount of contributions rises with age, although at a decreasing rate (AGE) until the age of 45, whereafter contributions begin to decline as individuals grow older. As shown in Table 4, the percentage of older people still making contributions falls sharply, although the average amount set aside rises. Secondly, salaried employees make smaller contributions than people in other occupations (SALARIED). Meanwhile, we have been able to confirm that membership of an occupational pension plan stimulates investment in personal plans (OCCUPATIONALP), and that people benefiting from higher sponsor's contributions to such plans invest less in their personal plans than they would were the sponsor's While the above variables refer to prudential reasons for setting up a personal pension plan, there is another significant variable which is related with tax planning. In fact, contributions grow with income, although once again at a decreasing rate (INCOME) up to a threshold of 10.6 million pesetas (approximately € 64,000) covering the earnings of 99 percent of income taxpayers. Thereafter, the amount of contributions begins to decrease as income rises.

The last variable found to be significant in the estimation of the model expressed in [14] is the amount of mortgage repayments (MORTGAGE). This variable also took the expected sign and fits both with prudential and tax planning arguments for pension plan investment. Based on Table 5, we may affirm that taxpayers set aside less by way of private pension plan contributions as the amount of mortgage repayments made during the year rises.

In light of these results, we may conclude that individuals decide to invest in personal pension plans on complex grounds combining the wish to benefit from tax savings and to ensure they will receive supplementary income upon retirement. These results are in line with those obtained by literature in other countries.

[]TABLE 5 ABOUT HERE]

Tables A1 andA2 given in the Appendix respectively reflect the estimation of the prudential and tax planning models. In the former, age and the three variables related with investment in pension plans (membership of occupational pension plans, employer's contributions and prior contributions) are significant and take the expected signs. In the tax planning model, meanwhile, the significant variables are income, tax bill and mortgage repayments, which once again take the expected signs.

Concluding remarks

In this paper, we have examined the variables affecting the decisions to invest in a personal pension plan and the amount of contributions. We have found a combination of prudential and tax planning reasons for these decisions. Age and occupation affect individuals, as do membership of occupational pension plans, and previous contributions to their own personal plans, as well as the cost of mortgage repayments and income levels.

Our empirical study uses 1995 data, seven years after the first regulation of pension plans. In that year, these instruments had come to represent 4.4 percent of assets held by private individuals. Eight years on, this share has risen to 6.2 percent, confirming the consolidation of these prudential savings vehicles. Consequently, it will be necessary to repeat the estimations carried out in order to confirm whether, as we believe, the variables that explain investment in pension plans in 1995 remain significant in the present. 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Introduction

The tax treatment of pension plans is currently a matter of some debate in Spain.

The government's position is that the favourable tax treatment accorded to such instruments provides an incentive for the better off to invest, while the lower and middle income groups hardly make any use of them. Thus, investment in pension plans is more a matter of tax planning than financial prudence in anticipation of retirement. This paper seeks to make a contribution to this debate, and to this end we shall use information provided in 1995 personal income tax returns to investigate the reasons underlying the two decisions made by the holders of pension plans, first to set up a plan and then to make contributions for a given amount.

The Spanish Pension Plans and Funds Regulation Act, 1987 (Law 8/June 8, 1987) regulated pension plans, defined as voluntary prudential institutions providing benefits supplementing those of the public social security system. The Act refers to three types of pension plan depending on the person who offers them. These are "occupational schemes" in which the sponsor of the pension plan is an organisation, corporation, company or firm (that is, an employer) and the members are employees; "associated schemes" sponsored by associations or trade unions for their members or affiliates; and "personal schemes" sponsored by one or more financial entities and having private individuals as their members. In this paper, we shall focus on personal pension plans.

Pension plans may also be classified on the basis of the obligations provided for in the contract. Thus, "defined benefits plans" fix the amount of the final pension the beneficiaries will receive; "defined contributions plans" establish the amount of the contributions the sponsors and, where applicable, participants must make; and "mixed plans" simultaneously stipulate eventual benefits and the amount of contributions. While occupational and associated pension plans may fall into any of these three categories, personal pension plans will always be defined contributions schemes.

Pension plans have received a highly favourable tax treatment since they were first regulated in 1987, and as a result they now represent a growing part of the financial assets held by individuals.

The rest of this paper is structured as follows. In Section 2, we outline the tax regime applicable to pension plans in Spain since 1987. The data presented are expressed in terms of the internal rate of return of pension plans in the three following periods: from 1987 to 1991, with the initial regulation for pension plans; from 1992 to 1998, after the 1991 Spanish Personal Income Tax reform; and from 1999 onwards, following the 1998 reform.

The applied model is set out and discussed in Section 3. In order to discover the factors explaining the decisions associated with investment in personal pension plans, we specify and estimate a Tobit model for a sample drawn from the 1995 Personal Income Taxpayers Panel prepared by the Institute of Fiscal Studies (Spanish Ministry of Economy and Finance). Our conclusion from this exercise is that the holders of personal pension plans are motivated both by reasons of financial prudence and tax savings.

Section 4 ends the paper with some final considerations.

The tax treatment of pension plans

In this section, we shall describe the tax treatment of pension plans and quantify their internal rate of return (IRR) since 1987. This analysis distinguishes between the three moments at which the tax treatment affects investment in pension plans, namely when contributions are made, during the accumulation of returns, and when the benefit contracted is received. 1 Table 1 shows the expressions for the IRR of the pension plans in the three periods considered. The tax treatment of the plans is summarised in Table 2.

[TABLES 1 and 2 ABOUT HERE]

Contributions

The contributions made to pension plans are tax allowable in the contributor's Personal Income Tax within certain limits. Initially, in the period 1987-1991, the contribution could be deducted from taxable income provided the amount of the deduction was less than 15 percent of the sum of net earnings from work and business activities (earned income) or 500,000 pesetas. The remaining contributions were eligible for a 15 percent tax credit up to a limit of 750,000 pesetas. In the early years, these limits were applied to each tax return, but this changed in 1989, when married people were allowed to file separate returns, and tax credits and allowances became applicable to each taxpayer included in the return.

There were two key changes to the tax treatment of contributions to pension plans in the ensuing years. Firstly, the 15 percent tax credit was removed (1992) and, secondly, the absolute and relative limits on the deduction from taxable income were raised.

Since 2003 the absolute deduction for people aged under 53 years has been € 8,000, with an additional € 1,250 for each additional year over the age of 52 to a maximum of € 24,250 for pension plan contributors aged over 65. Meanwhile, the relative limit on 1 See Scholes et al.(2002). Antolín, de Serrres, and de la Maisonneuve ( 2004) and Yoo and de Serres ( 2004) examine the tax treatment of private pensions in the OECD countries. Based on this regulatory framework, let us initially assume an initial capital IC available for investment in a pension plan. The contribution made produces tax savings.

Given that the unit deduction will differ depending on whether it is applied to taxable income or tax liability, which shall denote each alternative by d q , where q takes the value 1 or 2, respectively, for deductions from taxable income or tax liability. If the contribution is deductible from taxable income, d 1 = t px , where t px is the marginal rate subject to the age x at which the taxpayer made the contribution. If it is deductible from tax liability, then d 2 = 0,15.

Hence, the net initial capital, NIC, will be equal to:

) 1 ( q d IC NIC = [1]

Accumulation

The returns generated by pension plans are not taxable during the accumulation period. In the first place, the pension plan holder does not pay any Income Tax on the returns generated, which are not imputed to him. Meanwhile, the pension fund itself, though subject to Corporate Income Tax, benefits from a zero tax rate. Thus, the fund is required to file a corporate income tax return, but only to recover amounts withheld at source. Finally, Net Wealth Tax is not levied on the investment, because the vested rights in the plan were not initially subject to the tax, and they are currently exempt.

Hence, the net rate of interest on the pension plan investment is:

F o r P e e r R e v i e w 6 i t i i s N = = ) 1 ( [2]
where i is the nominal gross rate, and t s the corporate tax rate.

If x is the age of the individual making contributions to the pension plan, and j is her age upon retirement, the final capital accumulated will thus be:

x j x j N i IC i IC FC + = + = ) 1 ( ) 1 ( [3]

Benefits

Pension benefits could be withdrawn in the form of lump-sums or in the form of annuities. We will refer here only to the first case. When benefits are paid, the total amount is included in taxable income by way of earnings from labour. The way in which the tax base is established and the applicable tax rate calculated has changed over time.

As shown in Table 2, the benefits received from the plan are eligible for an allowance. This was initially 2 percent of the returns obtained and is currently 40 percent.

Between 1987 and 1998, the annualised returns (i.e. the quotient of taxable returns and the number of years in which they were generated) were taxed at the marginal tax rate.

The remainder returns were taxed at the average rate, because it would not be equitable to apply a progressive tax schedule to returns generated over a number of years. So, the tax rate applicable to benefits is the weighted average of the average and marginal tax rates at the time the funds are withdrawn. Since 1999, the taxable part of pension plan benefits have been taxed at the relevant marginal tax rate.

Let us call the tax rate applicable to benefits t e , and the taxable part of the final capital obtained g. The tax liability will now be: And the net final capital will be:

) 1 ( ) 1 ( ) 1 ( g t i IC g t FC T FC NFC e x j e P + = = = [5]
The formula for IRR is:

1 1 1 ) 1 ( 1 1 1 + = = x j q e x j d t g i NIC NFC IRR [6]
The IRR of pension plans has grown continuously since 1987 thanks to the tax regime, which is more favourable than for any other savings instrument. As shown in Figure 1, these assets have gradually increased their share of the portfolios held by individuals to somewhat more than 6 percent at present. 2

[FIGURE 1 ABOUT HERE]

Income, age and pension plan investment

Let us now focus on the variables influencing the decision to invest in a personal pension plan. Based on the expression of IRR, we can predict the relationship between pension plan investment and the investor's income. Since the year considered in the present empirical study is 1995, we shall work with the IRR expression for the period 1992-1998, which is:

2 Figure 1 was constructed on the basis of the Financial Accounts of the Spanish Economy, prepared by the Bank of Spain. Exhaustive information concerning pension plans in Spain is available in Dirección General de Seguros y Fondos de Pensiones (2004) In order to obtain the relationship between IRR and income levels, we first need to establish the relationship between the marginal tax rate at the time the contribution is made, t px , and the tax rate levied on the benefits, t e . As explained above, the latter is the weighted average of the average and marginal tax rates at the time the benefit is paid. We may therefore make the general assumption that it will be related to the initial marginal tax rate in the following manner:

px e t k t = , 1 0 < < k [7]
Thus, the pension plan participant's income at the time the benefit is received, and hence the applicable tax rate, will be a given proportion of the income she received and the applicable tax rate applied while she was active. We may now calculate how IRR will vary when t px changes:

( ) ( )

0 1 1 1 1 ) ( 1 2 1 1 > + = px x j px e px t k g t t g x j i t IRR [8]
Accordingly, the IRR of pension plans rises in line with contributors' incomes and the applicable tax rates. We may therefore expect to find a positive relationship between income and pension plan contributions.

Let us look now at the incentive to invest in pension plans and age. The IRR of pension savings is of no use to us here, because investments of differing duration cannot be compared on this basis. Consequently, we shall calculate the net present value of the investment in the plan, assuming that the alternative investment is tax exempt. Based on the net initial and final capital respectively given in [1] and [5], the net present value of a one euro investment in a pension plan would be:

) 1 ( ) 1 ( ) 1 ( ) 1 ( ) 1 ( k g t t
= = + = = + + = [9]
Hence, anybody investing in a personal pension plan obtains a subsidy per unit invested, which is the same at any age. This subsidy represents compensation for the absence of liquidity inherent in pension plans. However, if we take into account that the loss of liquidity diminish as people grow older and the recovery of the investment draws nearer, we may conclude that the incentive to invest in pension plans is greater for older people.

Empirical evidence for personal pension plan investment decisions

In this section, we seek to answer the two questions forming the objective of this paper. What variables influence the decision to invest in a personal pension plan? And, what variables affect the amount individuals decide to contribute to their pension plans?

To answer these questions, we shall specify and estimate a Tobit model for a 1995 sample (the latest available) from the Institute of Fiscal Studies Personal Income Taxpayers Panel.

The sample is formed by 3,041 tax returns, of which 358 include contributions to personal pension plans.

( ) ( ) + = > = i i i i i i i i u X Y X Y Y X Y 0 , / 0 0 , / * * [10]
In the first stage a Probit model is used to determine the probability that the variable * i Y will take a value of zero rather than a positive value. In the second stage, a real and positive value is assigned to the variable Y i after a positive value has been probabilistically given to * i Y , and the following model is specified with the subset of observations having a regressand other than zero:

i i i u X Y + = * [11]
where are the coefficients, X i the regressors, and u i is the error term, which is a random variable distributed based on normal N(0, 2 ).

In our model, the dependent variable is the amount of contributions made to pension plans. The explanatory variables are those usually considered in the literature4 , to which have added some others that are specific to the reality of Spain. The variables used and the expected sign for each are shown in Table 3. declare contributions to personal pension plans, the average amount of which was 150,564 pesetas. 5The regressors considered were as follows:

Age. Based on the argument derived from expression [9], we may expect to find a positive relationship between age and the contributions made to pension plans. This variable has been included quadratically as well.

Marital status. We have used a dummy variable with a value of zero for unmarried and one for married taxpayers. We opted to assign a positive sign to this variable, because we believe that prudential behaviour is more likely in the case of married people.

Income level. Based on expression [8]

, we may expect a positive relationship between individuals' income levels (i.e. taxable income prior to tax allowance for contributions) and the amount of the contributions made to pension plans. For the same reason, we may assign a positive value to the variable marginal tax rate. In addition, higher earners will also have greater capacity for savings. The income variable has also been included quadratically.

Occupation. We have used dummy variables for the categories entrepreneurs, professionals and salaried employees. We consider that the first two categories are likely to make higher contributions than employees because their mandatory social security contributions are smaller. Also, we would expect professionals to make higher contributions because they are, in general, better educated and are likely to be more aware of the advantages of this saving instrument . Year-end tax bill. The aim of this variable is to verify the hypothesis that people invests in pension plans with a view to reducing their year-end tax bill (i.e. the part of income tax not paid through withholdings at source), which is due upon the presentation of the income tax return. Thus, the higher the tax bill, the higher will be the pension plan contributions made.

Membership of occupational pension plans.

Our hypothesis is that membership of occupational pension schemes will encourage the participation on personal plans. We have employed a dummy variable with a value of one for taxpayers who are members of occupational schemes and zero for those who are not. In the case of the former, however, we expect the contributions made to fall as the employer's contribution rises. This variable has been assigned a negative sign.

Prior year's contribution. We believe that the behaviour of people contributing to pension plans may be to some extent routine, with the result that they will continue to contribute a roughly similar amount each year after setting up the plan. Consequently, we have assigned a positive sign to this variable.

Mortgage repayments.

A person who is still repaying the mortgage on his home will have less spare cash to contribute to his pension plan. The higher these mortgage repayments are, the less the person will contribute to the plan.

Life insurance contributions.

Like pension plans, life insurance policies are prudential savings instruments, although they do not have the same characteristics. While pension plans receive a more favourable tax treatment, life insurance are more liquid. If pension plans and life insurance are substitute assets, we may expect that higher life personal pension plans in 1995, investing an average of 132,823 pesetas. In 2004, 7,224,792 people made contributions, investing an average of € 746,87 (124,000 pesetas). 13 insurance contributions will be associated with smaller contributions to pension plans. On the other hand, if they act as complementary assets (as table 4 would seem to indicate), this relationship will be the reverse. In short, we are unable to assign a positive or negative sign to this variable.

[TABLES 3 and4 ABOUT HERE] The relationship between investment in the home, pension plans and life insurance is clearly apparent in figures 2 and 3, which are constructed on the basis of the sample of tax returns used for the applied study of 1995. It may be observed in figure 2, that buying a house is the most important investment made by people in their lifetimes. However, mortgage repayments begin to fall after the age of 50. Contributions to pension plans and life insurance are considerably smaller, but increase as individuals age. Average pension plan contributions rise fastest among people aged over 60, while life insurance contributions fall after the age of 65.

Figure 3, which takes income levels into account, reflects sustained growth in average mortgage repayments along the income scale. This effect is particularly pronounced in the two upper deciles. There is also a slight rise in investment in pension plans and life insurance until the last two deciles, where average contributions increase sharply, especially in the case of pension plans.

[FIGURES 2 and 3 ABOUT HERE]

Based on the above variables, we have specified three models which provide alternative explanations for the decision to invest in a personal pension plan. The first of these, which we shall call the "prudential model", is based on the hypothesis that individuals invest in pension plans basically to save against their retirement, perhaps as a The second "tax planning model" refers to the hypothesis that the individual's main motivation is to obtain the tax benefits available to investors in pension plans. The exogenous variables included in the model are income level, marginal tax rate, year-end tax bill, mortgage repayments and life insurance contributions. The specification is:

F
) , , , , , ( 2 INSURANCE MORTGAGE TAXBILL MARGINALT INCOME C f PLAN = [13]
Finally, the "general model" includes all of the exogenous variables and is based on the hypothesis that investment in pension plans can be explained both by prudential and tax planning concerns. The specification of the model is as follows:

) , , , , , , , , , , , , , ( 3 INSURANCE
IMORTGAGE PRIORC EMPLOYERC ALP OCCUPATION TAXBILL MARGINALT SALARIED AL PROFESSION UR ENTREPRENE INCOME STATUS AGE C f PLAN = [14]
The heteroskedastically robust estimation of the models was performed using the Econometric Views (Eviews) application, version 3.1. Using the logarithm of the verisimilitude function and the Aikake, Schwarz and Hannan-Quinn criteria as the selection criteria, we chose the general model as the most adequate. The results of the estimation are shown in Table 5. The variables found to be significant took the expected signs. In the first place, the amount of contributions rises with age, although at a decreasing rate (AGE) until the age of 45, whereafter contributions begin to decline as individuals grow older. As shown in Table 4, the percentage of older people still making contributions falls sharply, although the average amount set aside rises. Secondly, salaried employees make smaller contributions than people in other occupations (SALARIED). Meanwhile, we have been able to confirm that membership of an occupational pension plan stimulates investment in personal plans (OCCUPATIONALP), and that people benefiting from higher sponsor's contributions to such plans invest less in their personal plans than they would were the sponsor's contribution smaller (EMPLOYERC). Furthermore, savings in a given year are positively affected by the prior year's contributions (PRIORC).

While the above variables refer to prudential reasons for setting up a personal pension plan, there is another significant variable which is related with tax planning. In fact, contributions grow with income, although once again at a decreasing rate (INCOME) up to a threshold of 10.6 million pesetas (approximately € 64,000) covering the earnings of 99 percent of income taxpayers. Thereafter, the amount of contributions begins to decrease as income rises.

The last variable found to be significant in the estimation of the model expressed in [14] is the amount of mortgage repayments (MORTGAGE). This variable also took the expected sign and fits both with prudential and tax planning arguments for pension plan investment. Based on Table 5, we may affirm that taxpayers set aside less by way of private pension plan contributions as the amount of mortgage repayments made during the year rises. In light of these results, we may conclude that individuals decide to invest in personal pension plans on complex grounds combining the wish to benefit from tax savings and to ensure they will receive supplementary income upon retirement. These results are in line with those obtained by literature in other countries.

[TABLE 5 ABOUT HERE] Tables A1 andA2 given in the Appendix respectively reflect the estimation of the prudential and tax planning models. In the former, age and the three variables related with investment in pension plans (membership of occupational pension plans, employer's contributions and prior contributions) are significant and take the expected signs. In the tax planning model, meanwhile, the significant variables are income, tax bill and mortgage repayments, which once again take the expected signs.

Concluding remarks

In this paper, we have examined the variables affecting the decisions to invest in a personal pension plan and the amount of contributions. We have found a combination of prudential and tax planning reasons for these decisions. Age and occupation affect individuals, as do membership of occupational pension plans, and previous contributions to their own personal plans, as well as the cost of mortgage repayments and income levels.

Our empirical study uses 1995 data, seven years after the first regulation of pension plans. In that year, these instruments had come to represent 4.4 percent of assets held by private individuals. Eight years on, this share has risen to 6.2 percent, confirming the consolidation of these prudential savings vehicles. Consequently, it will be necessary to 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Introduction

The tax treatment of pension plans is currently a matter of some debate in Spain.

The government's position is that the favourable tax treatment accorded to such instruments provides an incentive for the better off to invest, while the lower and middle income groups hardly make any use of them. Thus, investment in pension plans is more a matter of tax planning than financial prudence in anticipation of retirement. This paper seeks to make a contribution to this debate, and to this end we shall use information provided in 1995 personal income tax returns to investigate the reasons underlying the two decisions made by the holders of pension plans, first to set up a plan and then to make contributions for a given amount.

The Spanish Pension Plans and Funds Regulation Act, 1987 (Law 8/June 8, 1987) regulated pension plans, defined as voluntary prudential institutions providing benefits supplementing those of the public social security system. The Act refers to three types of pension plan depending on the person who offers them. These are "occupational schemes" in which the sponsor of the pension plan is an organisation, corporation, company or firm (that is, an employer) and the members are employees; "associated schemes" sponsored by associations or trade unions for their members or affiliates; and "personal schemes" sponsored by one or more financial entities and having private individuals as their members. In this paper, we shall focus on personal pension plans.

Pension plans may also be classified on the basis of the obligations provided for in the contract. Thus, "defined benefits plans" fix the amount of the final pension the beneficiaries will receive; "defined contributions plans" establish the amount of the contributions the sponsors and, where applicable, participants must make; and "mixed plans" simultaneously stipulate eventual benefits and the amount of contributions. While occupational and associated pension plans may fall into any of these three categories, personal pension plans will always be defined contributions schemes.

Pension plans have received a highly favourable tax treatment since they were first regulated in 1987, and as a result they now represent a growing part of the financial assets held by individuals.

The rest of this paper is structured as follows. In Section 2, we outline the tax regime applicable to pension plans in Spain since 1987. The data presented are expressed in terms of the internal rate of return of pension plans in the three following periods: from 1987 to 1991, with the initial regulation for pension plans; from 1992 to 1998, after the 1991 Spanish Personal Income Tax reform; and from 1999 onwards, following the 1998 reform.

The applied model is set out and discussed in Section 3. In order to discover the factors explaining the decisions associated with investment in personal pension plans, we specify and estimate a Tobit model for a sample drawn from the 1995 Personal Income Taxpayers Panel prepared by the Institute of Fiscal Studies (Spanish Ministry of Economy and Finance). Our conclusion from this exercise is that the holders of personal pension plans are motivated both by reasons of financial prudence and tax savings.

Section 4 ends the paper with some final considerations.

The tax treatment of pension plans

In this section, we shall describe the tax treatment of pension plans and quantify their internal rate of return (IRR) since 1987. This analysis distinguishes between the three moments at which the tax treatment affects investment in pension plans, namely when contributions are made, during the accumulation of returns, and when the benefit contracted is received. 1 Table 1 shows the expressions for the IRR of the pension plans in the three periods considered. The tax treatment of the plans is summarised in Table 2.

[TABLES 1 and 2 ABOUT HERE]

Contributions

The contributions made to pension plans are tax allowable in the contributor's Personal Income Tax within certain limits. Initially, in the period 1987-1991, the contribution could be deducted from taxable income provided the amount of the deduction was less than 15 percent of the sum of net earnings from work and business activities (earned income) or 500,000 pesetas. The remaining contributions were eligible for a 15 percent tax credit up to a limit of 750,000 pesetas. In the early years, these limits were applied to each tax return, but this changed in 1989, when married people were allowed to file separate returns, and tax credits and allowances became applicable to each taxpayer included in the return.

There were two key changes to the tax treatment of contributions to pension plans in the ensuing years. Firstly, the 15 percent tax credit was removed (1992) and, secondly, the absolute and relative limits on the deduction from taxable income were raised.

Since 2003 the absolute deduction for people aged under 53 years has been € 8,000, with an additional € 1,250 for each additional year over the age of 52 to a maximum of € 24,250 for pension plan contributors aged over 65. Meanwhile, the relative limit on 1 See Scholes et al.(2002). Antolín, de Serrres, and de la Maisonneuve ( 2004) and Yoo and de Serres ( 2004) examine the tax treatment of private pensions in the OECD countries. Based on this regulatory framework, let us initially assume an initial capital IC available for investment in a pension plan. The contribution made produces tax savings.

Given that the unit deduction will differ depending on whether it is applied to taxable income or tax liability, which shall denote each alternative by d q , where q takes the value 1 or 2, respectively, for deductions from taxable income or tax liability. If the contribution is deductible from taxable income, d 1 = t px , where t px is the marginal rate subject to the age x at which the taxpayer made the contribution. If it is deductible from tax liability, then d 2 = 0,15.

Hence, the net initial capital, NIC, will be equal to:

) 1 ( q d IC NIC = [1]

Accumulation

The returns generated by pension plans are not taxable during the accumulation period. In the first place, the pension plan holder does not pay any Income Tax on the returns generated, which are not imputed to him. Meanwhile, the pension fund itself, though subject to Corporate Income Tax, benefits from a zero tax rate. Thus, the fund is required to file a corporate income tax return, but only to recover amounts withheld at source. Finally, Net Wealth Tax is not levied on the investment, because the vested rights in the plan were not initially subject to the tax, and they are currently exempt.

Hence, the net rate of interest on the pension plan investment is:

F o r P e e r R e v i e w 6 i t i i s N = = ) 1 ( [2]
where i is the nominal gross rate, and t s the corporate tax rate.

If x is the age of the individual making contributions to the pension plan, and j is her age upon retirement, the final capital accumulated will thus be:

x j x j N i IC i IC FC + = + = ) 1 ( ) 1 ( [3]

Benefits

Pension benefits could be withdrawn in the form of lump-sums or in the form of annuities. We will refer here only to the first case. When benefits are paid, the total amount is included in taxable income by way of earnings from labour. The way in which the tax base is established and the applicable tax rate calculated has changed over time.

As shown in Table 2, the benefits received from the plan are eligible for an allowance. This was initially 2 percent of the returns obtained and is currently 40 percent.

Between 1987 and 1998, the annualised returns (i.e. the quotient of taxable returns and the number of years in which they were generated) were taxed at the marginal tax rate.

The remainder returns were taxed at the average rate, because it would not be equitable to apply a progressive tax schedule to returns generated over a number of years. So, the tax rate applicable to benefits is the weighted average of the average and marginal tax rates at the time the funds are withdrawn. Since 1999, the taxable part of pension plan benefits have been taxed at the relevant marginal tax rate.

Let us call the tax rate applicable to benefits t e , and the taxable part of the final capital obtained g. The tax liability will now be: And the net final capital will be:

) 1 ( ) 1 ( ) 1 ( g t i IC g t FC T FC NFC e x j e P + = = = [5]
The formula for IRR is:

1 1 1 ) 1 ( 1 1 1 + = = x j q e x j d t g i NIC NFC IRR [6]
The IRR of pension plans has grown continuously since 1987 thanks to the tax regime, which is more favourable than for any other savings instrument. As shown in Figure 1, these assets have gradually increased their share of the portfolios held by individuals to somewhat more than 6 percent at present. 2

[FIGURE 1 ABOUT HERE]

Income, age and pension plan investment

Let us now focus on the variables influencing the decision to invest in a personal pension plan. Based on the expression of IRR, we can predict the relationship between pension plan investment and the investor's income. Since the year considered in the present empirical study is 1995, we shall work with the IRR expression for the period 1992-1998, which is:

2 Figure 1 was constructed on the basis of the Financial Accounts of the Spanish Economy, prepared by the Bank of Spain. Exhaustive information concerning pension plans in Spain is available in Dirección General de Seguros y Fondos de Pensiones (2004) and at the website of INVERCO, Asociación de Instituciones de Inversión Colectiva y Fondos de Pensiones: www.inverco.es. [START_REF] Blake | Modelling The Composition of Personal Sector Wealth in theUK[END_REF] investigates the allocation of UK personal sector wealth across five asset categories (net financial wealth, housing wealth, state pension wealth, private pension wealth, and human capital) using the financial AIDS model. He finds that, apart from total wealth and returns, other variables relating to capital market imperfections, and demographic, labour market and cross-sector spillover effects turn out to be significant. In order to obtain the relationship between IRR and income levels, we first need to establish the relationship between the marginal tax rate at the time the contribution is made, t px , and the tax rate levied on the benefits, t e . As explained above, the latter is the weighted average of the average and marginal tax rates at the time the benefit is paid. We may therefore make the general assumption that it will be related to the initial marginal tax rate in the following manner:

px e t k t = , 1 0 < < k [7]
Thus, the pension plan participant's income at the time the benefit is received, and hence the applicable tax rate, will be a given proportion of the income she received and the applicable tax rate applied while she was active. We may now calculate how IRR will vary when t px changes:

( ) ( )

0 1 1 1 1 ) ( 1 2 1 1 > + = px x j px e px t k g t t g x j i t IRR [8]
Accordingly, the IRR of pension plans rises in line with contributors' incomes and the applicable tax rates. We may therefore expect to find a positive relationship between income and pension plan contributions.

Let us look now at the incentive to invest in pension plans and age. The IRR of pension savings is of no use to us here, because investments of differing duration cannot be compared on this basis. Consequently, we shall calculate the net present value of the investment in the plan, assuming that the alternative investment is tax exempt. Based on the net initial and final capital respectively given in [1] and [5], the net present value of a one euro investment in a pension plan would be:

) 1 ( ) 1 ( ) 1 ( ) 1 ( ) 1 ( k g t t
= = + = = + + = [9]
Hence, anybody investing in a personal pension plan obtains a subsidy per unit invested, which is the same at any age. This subsidy represents compensation for the absence of liquidity inherent in pension plans. However, if we take into account that the loss of liquidity diminish as people grow older and the recovery of the investment draws nearer, we may conclude that the incentive to invest in pension plans is greater for older people.

Empirical evidence for personal pension plan investment decisions

In this section, we seek to answer the two questions forming the objective of this

( ) ( ) + = > = i i i i i i i i u X Y X Y Y X Y 0 , / 0 0 , / * * [10]
In the first stage a Probit model is used to determine the probability that the variable * i Y will take a value of zero rather than a positive value. In the second stage, a real and positive value is assigned to the variable Y i after a positive value has been probabilistically given to * i Y , and the following model is specified with the subset of observations having a regressand other than zero:

i i i u X Y + = * [11]
where are the coefficients, X i the regressors, and u i is the error term, which is a random variable distributed based on normal N(0, 2 ).

In our model, the dependent variable is the amount of contributions made to pension plans. The explanatory variables are those usually considered in the literature 4 , to which have added some others that are specific to the reality of Spain. The variables used and the expected sign for each are shown in Table 3. declare contributions to personal pension plans, the average amount of which was 150,564 pesetas. 5 The regressors considered were as follows:

Age. Based on the argument derived from expression [9], we may expect to find a positive relationship between age and the contributions made to pension plans. This variable has been included quadratically as well.

Marital status. We have used a dummy variable with a value of zero for unmarried and one for married taxpayers. We opted to assign a positive sign to this variable, because we believe that prudential behaviour is more likely in the case of married people.

Income level. Based on expression

[8], we may expect a positive relationship between individuals' income levels (i.e. taxable income prior to tax allowance for contributions) and the amount of the contributions made to pension plans. For the same reason, we may assign a positive value to the variable marginal tax rate. In addition, higher earners will also have greater capacity for savings. The income variable has also been included quadratically.

Occupation. We have used dummy variables for the categories entrepreneurs, professionals and salaried employees. We consider that the first two categories are likely to make higher contributions than employees because their mandatory social security contributions are smaller. Also, we would expect professionals to make higher contributions because they are, in general, better educated and are likely to be more aware of the advantages of this saving instrument . Year-end tax bill. The aim of this variable is to verify the hypothesis that people invests in pension plans with a view to reducing their year-end tax bill (i.e. the part of income tax not paid through withholdings at source), which is due upon the presentation of the income tax return. Thus, the higher the tax bill, the higher will be the pension plan contributions made.

Membership of occupational pension plans.

Our hypothesis is that membership of occupational pension schemes will encourage the participation on personal plans. We have employed a dummy variable with a value of one for taxpayers who are members of occupational schemes and zero for those who are not. In the case of the former, however, we expect the contributions made to fall as the employer's contribution rises 6 . This variable has been assigned a negative sign.

Prior year's contribution. We believe that the behaviour of people contributing to pension plans may be to some extent routine, with the result that they will continue to contribute a roughly similar amount each year after setting up the plan. Consequently, we have assigned a positive sign to this variable.

Mortgage repayments.

A person who is still repaying the mortgage on his home will have less spare cash to contribute to his pension plan. The higher these mortgage repayments are, the less the person will contribute to the plan.

Life insurance contributions.

Like pension plans, life insurance policies are prudential savings instruments, although they do not have the same characteristics. While pension plans receive a more favourable tax treatment, life insurance are more liquid. If personal pension plans in 1995, investing an average of 132,823 pesetas. In 2004, 7,224,792 people made contributions, investing an average of € 746,87 (124,000 pesetas). 6 Quite a lot of papers examine the factors affecting the employer contributions to pension plans. For the UK, see [START_REF] Casey | Employer's Provision of Pensions and Sick Pay: Evidence from the 1990 Workplace Industrial Relations Survery[END_REF]; for the USA, see [START_REF] Kiker | Income, Taxes and Employer Pension Contributions[END_REF][START_REF] Kiker | Income, Taxes and Employer Pension Contributions[END_REF][START_REF] Bernstein | Fringe Benefits and Small Businesses: Evidence from the Federal Reserve Board Small Business Survey[END_REF]. 13 pension plans and life insurance are substitute assets, we may expect that higher life insurance contributions will be associated with smaller contributions to pension plans. On the other hand, if they act as complementary assets (as table 4 would seem to indicate), this relationship will be the reverse. In short, we are unable to assign a positive or negative sign to this variable.

[TABLES 3 and 4 ABOUT HERE]

The relationship between investment in the home, pension plans and life insurance is clearly apparent in figures 2 and 3, which are constructed on the basis of the sample of tax returns used for the applied study of 1995. It may be observed in figure 2, that buying a house is the most important investment made by people in their lifetimes. However, mortgage repayments begin to fall after the age of 50. Contributions to pension plans and life insurance are considerably smaller, but increase as individuals age. Average pension plan contributions rise fastest among people aged over 60, while life insurance contributions fall after the age of 65.

Figure 3, which takes income levels into account, reflects sustained growth in average mortgage repayments along the income scale. This effect is particularly pronounced in the two upper deciles. There is also a slight rise in investment in pension plans and life insurance until the last two deciles, where average contributions increase sharply, especially in the case of pension plans.

[FIGURES 2 and 3 ABOUT HERE] Based on the above variables, we have specified three models which provide alternative explanations for the decision to invest in a personal pension plan. The first of these, which we shall call the "prudential model", is based on the hypothesis that The second "tax planning model" refers to the hypothesis that the individual's main motivation is to obtain the tax benefits available to investors in pension plans. The exogenous variables included in the model are income level, marginal tax rate, year-end tax bill, mortgage repayments and life insurance contributions. The specification is:

) , , , , , ( 2 INSURANCE MORTGAGE TAXBILL MARGINALT INCOME C f PLAN = [13]
Finally, the "general model" includes all of the exogenous variables and is based on the hypothesis that investment in pension plans can be explained both by prudential and tax planning concerns. The specification of the model is as follows:

) , , , , , , , , , , , , , ( 3 INSURANCE
IMORTGAGE PRIORC EMPLOYERC ALP OCCUPATION TAXBILL MARGINALT SALARIED AL PROFESSION UR ENTREPRENE INCOME STATUS AGE C f PLAN = [14]
The heteroskedastically robust estimation of the models was performed using the The variables found to be significant took the expected signs. In the first place, the amount of contributions rises with age, although at a decreasing rate (AGE) until the age of 45, whereafter contributions begin to decline as individuals grow older. As shown in Table 4, the percentage of older people still making contributions falls sharply, although the average amount set aside rises. Secondly, salaried employees make smaller contributions than people in other occupations (SALARIED). Meanwhile, we have been able to confirm that membership of an occupational pension plan stimulates investment in personal plans (OCCUPATIONALP), and that people benefiting from higher sponsor's contributions to such plans invest less in their personal plans than they would were the sponsor's contribution smaller (EMPLOYERC). Furthermore, savings in a given year are positively affected by the prior year's contributions (PRIORC).

While the above variables refer to prudential reasons for setting up a personal pension plan, there is another significant variable which is related with tax planning. In fact, contributions grow with income, although once again at a decreasing rate (INCOME) up to a threshold of 10.6 million pesetas (approximately € 64,000) covering the earnings of 99 percent of income taxpayers. Thereafter, the amount of contributions begins to decrease as income rises.

The last variable found to be significant in the estimation of the model expressed in [14] is the amount of mortgage repayments (MORTGAGE). This variable also took the expected sign and fits both with prudential and tax planning arguments for pension plan investment. Based on Table 5, we may affirm that taxpayers set aside less by way of private pension plan contributions as the amount of mortgage repayments made during the year rises. In light of these results, we may conclude that individuals decide to invest in personal pension plans on complex grounds combining the wish to benefit from tax savings and to ensure they will receive supplementary income upon retirement. These results are in line with those obtained by literature in other countries.

[TABLE 5 ABOUT HERE] Tables A1 andA2 given in the Appendix respectively reflect the estimation of the prudential and tax planning models. In the former, age and the three variables related with investment in pension plans (membership of occupational pension plans, employer's contributions and prior contributions) are significant and take the expected signs. In the tax planning model, meanwhile, the significant variables are income, tax bill and mortgage repayments, which once again take the expected signs.

Concluding remarks

In this paper, we have examined the variables affecting the decisions to invest in a personal pension plan and the amount of contributions. We have found a combination of prudential and tax planning reasons for these decisions. Age and occupation affect individuals, as do membership of occupational pension plans, and previous contributions to their own personal plans, as well as the cost of mortgage repayments and income levels.

Our empirical study uses 1995 data, seven years after the first regulation of pension plans. In that year, these instruments had come to represent 4.4 percent of assets held by private individuals. Eight years on, this share has risen to 6.2 percent, confirming the consolidation of these prudential savings vehicles. Consequently, it will be necessary to 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

  the following model is specified with the subset of observations having a regressand other than zero:

  to fall after the age of 50. Contributions to pension plans and life insurance are considerably smaller, but increase as individuals age. Average pension plan contributions rise fastest among people aged over 60, while life insurance contributions fall after the age of 65.

F

  EMPLOYERC). Furthermore, savings in a given year are positively affected by the prior year's contributions (PRIORC).

Figure2

  Figure2. Ageand average i nvestmentin assets.

  in 2002, and the maximum allowable contribution has since been 100 percent of taxable income excluding capital gains.

  FollowingCabrer, Sancho, and Serrano (2001), the specification of the model is as follow3 . The regressand Y i can take a value of zero or the value of the variable * i Y , known as the latent variable:

  carried out in order to confirm whether, as we believe, the variables that explain investment in pension plans in 1995 remain significant in the present. *

  in 2002, and the maximum allowable contribution has since been 100 percent of taxable income excluding capital gains.

  Econometric Views (Eviews) application, version 3.1. Using the logarithm of the verisimilitude function and the Akaike, Schwarz and Hannan-Quinn criteria as the selection criteria, we chose the general model as the most adequate. The results of the estimation are shown in Table 5.

  carried out in order to confirm whether, as we believe, the variables that explain investment in pension plans in 1995 remain significant in the present. *

TABLE 1 . Pension plan IRR, 1987-2004

 1

	F o
	r
	P e
	e
	r
	R e
	v i
	e w

*

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

TABLE 2 . Tax treatment of pension plans

 2

			1987 -1991	1992 -1998		1999 -2004
	CONTRIBUTIONS
	Tax saving		tpx or 15%	tpx			tpx
						Up to 52 years	> 52 years
					In 1999:	Ptas. 1,100,000	----
	Limits on				In 2000-01: Ptas. 1,200,000	2000-01:+ Ptas. 100,000 (age-52)
	allowances and	--Absolute	Ptas. 500,000 -750,000	Ptas. 750,000 -1,100,000	In 2002:	Ptas. 1,200,000	In 2002:+ Ptas. 200,000 (age-52)
	tax credits				Since 2003: € 8,000	Since 2003: + €1,250 (age-52)
		--Relative	15% earned income	15%-20% earned income	100% general taxable income	100% general taxable income
					(In 1999-01: 20%, 25%)	(In 1999-01: 20%, 25%, 40%)
	ACCUMULATION
	Corporate income tax			Zero rate
	Net Wealth Tax		Not subject	Exempt			Exempt
	BENEFITS
	Tax base		Final capital	Final capital		Final capital
	Taxable returns		98%	95% -100%			60%
	Applicable tax rate		te	te			tpj
	Source: Own work.

TABLE 3 . Variables and expected sign

 3

	Variable	Symbol	Expected sign
	Contributions to pension plans Age Marital status Income level	PLAN AGE STATUS INCOME	+ + +
	Business activity Professional activity Salaried employment Marginal tax rate Year-end tax bill Membership of occupational scheme Employer´s contribution Prior year's contribution	ENTREPRENEUR PROFESSIONAL SALARIED MARGINALT TAXBILL OCCUPATIONALP EMPLOYERC PRIORC	¿? + -+ + + -+
	Mortgage repayments Life insurance contributions	MORTGAGE LINSURANCE	-¿?

TABLE 4 . Personal pension plan membership and average contributions

 4

	VARIABLE		PERCENTAGE CONTRIBUTORS	AVERAGE CONTRIBUTION (pesetas)
	TOTAL		11.77	150,564
	AGE	20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65	3.33 4.03 9.52 11.82 15.99 20.23 16.03 9.05 6.60	76,100 71,294 107,387 143,148 157,821 168,435 162,782 182,430 213,851
	MARITAL STATUS	Unmarried Married	10.30 13.12	123,855 169,825
	INCOME LEVEL	Decile 1 Decile 2 Decile 3 Decile 4 Decile 5 Decile 6 Decile 7 Decile 8 Decile 9 Decile 10	2.63 3.95 5.59 6.25 7.57 10.53 11.18 15.13 21.38 33.55	50,323 82,919 81,680 88,752 94,569 116,845 92,666 106,532 152,520 250,495
	OCCUPATION	Entrepreneur Professional Salaried employee	11.52 21.30 11.74	156,509 212,584 147,810
	MARGINAL TAX RATE	0.0% 20.0% 22.0% 24.5% 27.0% 30.0% 32.0% 34.0% 36.0% 38.0% 40.0% 42.5% 45.0% 47.0% 49.0% 51.0% 53.5%	3.65 4.51 6.24 8.73 12.23 17.54 19.77 23.30 30.00 22.22 35.48 46.15 27.78 41.67 37.50 9.09 52.38	72,952 101,716 86,341 98,111 103,398 134,515 147,252 165,826 118,837 286,168 184,481 195,188 167,069 395,785 515,049 151,029 390,886
	TAX BILL	Negative Positive	18.04 11.05	252,739 131,215
	PARTICIPATION IN OCCUPATIONAL PENSION PLAN	Yes No	54.64 10.36	101,415 159,105
	MORTGAGE REPAYMENTS	Yes No	15.12 10.50	122,641 165,916
	LIFE INSURANCE CONTRIBUTIONS	Yes No	23.52 9.04	190,944 126,118

TABLE 5 . Results of the Tobit estimation for the general model

 5

	Page 23 of 83		Submitted Manuscript
		Coefficient	Marginal Effect	Std. Error	z-Statistic	Prob.
	C	-772944.2	-64292.13	108576.3	-7.118904	0.0000
	AGE AGE*AGE	22964.83 -259.8054	1910.17 -21.68	4915.381 54.84662	4.672035 -4.736945	0.0000 0.0000
	INCOME	0.042513	0.003514	0.005972	7.118444	0.0000
	INCOME*INCOME	-1.98E-09	-1,64693E-10	4.19E-10	-4.732125	0.0000
	SALARIED OCCUPATIONALP	-38574.77 172098.7	-43470.35 43790.72	16299.70 29915.47	-2.366595 5.752832	0.0180 0.0000
	EMPLOYERC	-0.483151	-0.040188	0.067742	-7.132190	0.0000
	PRIORC	1.290833	0.107369	0.050385	25.61938	0.0000
	MORTGAGE	-0.025753	-0.002142 Error Distribution 0.011719	-2.197532	0.0280
	SCALE:C(11)	159924.4		4444.289	35.98424	0.0000
	R-squared	0.534140	Mean dependent var			17725.07
	Adjusted R-squared	0.532602	S.D. dependent var			73299.59
	S.E. of regression	50112.37	Akaike info criterion			3.479154
	Sum squared resid	7.61E+12	Schwarz criterion			3.500930
	Log likelihood Avg. log likelihood	-5279.054 -1.735960	Hannan-Quinn criter.		3.486981
	Left censored obs	2683	Right censored obs			0
	Uncensored obs	358	Total obs			3041

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

TABLE A1 . Results of the Tobit estimation for the prudential model

 A1

		Coefficient	Std. Error	z-Statistic	Prob.
	C	-918664.1	108308.6	-8.481915	0.0000
	AGE	31463.59	4931.230	6.380475	0.0000
	AGE*AGE	-350.2904	54.97829	-6.371431	0.0000
	OCCUPATIONALP EMPLOYERC	190266.5 -0.475665	32070.75 0.070643	5.932709 -6.733330	0.0000 0.0000
	PRIORC	1.466353	0.044976	32.60324	0.0000
		Error Distribution
	SCALE:C(7)	168214.5	3625.361	46.39937	0.0000
	R-squared	0.502038 Mean dependent var		17725.07
	Adjusted R-squared	0.501053 S.D. dependent var		73299.59
	S.E. of regression	51776.03 Akaike info criterion		3.499670
	Sum squared resid Log likelihood	8.13E+12 Schwarz criterion -5314.248 Hannan-Quinn criter.		3.513527 3.504651
	Avg. log likelihood	-1.747533
	Left censored obs	2683	Right censored obs		0
	Uncensored obs	358	Total obs		3041

TABLE A2 . Results of the Tobit estimation for the tax planning model

 A2

		Coefficient	Std. Error	z-Statistic	Prob.
	C	-574386.7	27999.27	-20.51434	0.0000
	INCOME	0.111300	0.008877	12.53834	0.0000
	INCOME*INCOME -4.10E-09 TAXBILL 0.045730	6.32E-10 0.019646	-6.490179 2.327738	0.0000 0.0199
	MORTGAGE	-0.071568	0.023655	-3.025521	0.0025
		Error Distribution
	SCALE:C(6)	266798.1	11630.07	22.94038	0.0000
	R-squared	0.208576 Mean dependent var		17725.07
	Adjusted R-squared	0.207272 S.D. dependent var		73299.59
	S.E. of regression	65262.49 Akaike info criterion		3.674403
	Sum squared resid Log likelihood	1.29E+13 Schwarz criterion -5580.930 Hannan-Quinn criter.		3.686280 3.678672
	Avg. log likelihood	-1.835228
	Left censored obs	2683	Right censored obs		0
	Uncensored obs	358	Total obs		3041

Age and average investment in different assets.

	Page 25 of 83									Page 26 of 83
		600,000
		500,000
		400,000
										Other
										Pension Funds
	Percentage Pesetas	300,000								Life insurance Investment funds Shares Mortgage repayments Pension plans Life insurance
										Bonds
										Deposits
		200,000
		100,000
		0
		25	30	35	40	45	50	55	60	2002 2003 65
						Years Age

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript F o r P e e r R e v i e w

Figure 2. Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript F o r P e e r R e v i e w

Figure 3.

Income levels and average investment in assets.

	Page 27 of 83						Submitted Manuscript
		1,000,000
		900,000
		800,000
		700,000
		600,000
	Pesetas	500,000		F o F o								Mortgage repayments Pension plans Life insurance
		400,000		r r
		300,000 200,000		P e P e e e
		100,000				r r
		0	1	2	3	4 R e R e	5	6	7	8	9	10
						Deciles i v v i
						e w e w

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Table 4 ,

 4 meanwhile, reflects the percentage of personal pension plan contributors for each variable, as well as the average contributions made. As the first row of this table shows, 11.77 percent of 1995 tax returns

	F o
	r
	P e
	e
	r
	R e
	v i
	e w

  supplement to other retirement funds obtained from sources such as the social security or life insurance. The explanatory variables in this model are age, marital status, occupation, membership of an occupational pension plan, employer's contributions, prior contributions, mortgage repayments and contributions to life insurance. The specification of the model is as follows:

	1 PLAN =	f	, ENTREPRENE MORTGAGE PRIORC , UR STATUS , EMPLOYERC , , ( AGE C	, ,	) PROFESSION INSURANCE AL	,	SALARIED	,	OCCUPATION	ALP	,	[12]
			o
			r
			P e
				e
					r
					R e
							v i
							e w

TABLE 1 . Pension plan IRR, 1987-2004

 1

	Period							IRR								g
																	1
	1987-1991	IRR P.87 =	1 (	+	i	)•	1 1 (	d g	q t	e	)	j	x	1	0.98
																	1
	1992-1998	IRR P.92 =	1 (	+	i	)•	1 1 (	t g	px t	e	)	j	x	1	0.95 or 1
	1999 and thereafter	IRR P.99 =	1 (	+	i	)•	1 (	1	t g	px t	pj	)	j	1	x	1	0.6 (if j-x>2)

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

TABLE 2 . Tax treatment of pension plans

 2

			Submitted Manuscript
			1987 -1991	1992 -1998		1999 -2004
	CONTRIBUTIONS
	Personal Income Tax saving	tpx or 15%	tpx			tpx
						Up to 52 years	> 52 years
					In 1999:	Ptas. 1,100,000	----
	Limits on				In 2000-01: Ptas. 1,200,000	2000-01:+ Ptas. 100,000 (age-52)
	allowances and	--Absolute	Ptas. 500,000 -750,000	Ptas. 750,000 -1,100,000	In 2002:	Ptas. 1,200,000	In 2002:+ Ptas. 200,000 (age-52)
	tax credits				Since 2003: € 8,000	Since 2003: + €1,250 (age-52)
		--Relative	15% earned income	15%-20% earned income	100% general taxable income	100% general taxable income
					(In 1999-01: 20%, 25%)	(In 1999-01: 20%, 25%, 40%)
	ACCUMULATION
	Corporate Income Tax			Zero rate
	Net Wealth Tax		Not subject	Exempt			Exempt
	BENEFITS
	Personal Income Tax base	Final capital	Final capital		Final capital
	Taxable returns		98%	95% -100%			60%
	Applicable tax rate		te	te			tpj
	Source: Own work.

Page 48 of 83 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

TABLE 4 . Personal pension plan membership and average contributions

 4

	VARIABLE		PERCENTAGE CONTRIBUTORS	AVERAGE CONTRIBUTION (pesetas)
	TOTAL		11.77	150,564
	AGE	20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65	3.33 4.03 9.52 11.82 15.99 20.23 16.03 9.05 6.60	76,100 71,294 107,387 143,148 157,821 168,435 162,782 182,430 213,851
	MARITAL STATUS	Unmarried Married	10.30 13.12	123,855 169,825
	INCOME LEVEL	Decile 1 Decile 2 Decile 3 Decile 4 Decile 5 Decile 6 Decile 7 Decile 8 Decile 9 Decile 10	2.63 3.95 5.59 6.25 7.57 10.53 11.18 15.13 21.38 33.55	50,323 82,919 81,680 88,752 94,569 116,845 92,666 106,532 152,520 250,495
	OCCUPATION	Entrepreneur Professional Salaried employee	11.52 21.30 11.74	156,509 212,584 147,810
	MARGINAL TAX RATE	0.0% 20.0% 22.0% 24.5% 27.0% 30.0% 32.0% 34.0% 36.0% 38.0% 40.0% 42.5% 45.0% 47.0% 49.0% 51.0% 53.5%	3.65 4.51 6.24 8.73 12.23 17.54 19.77 23.30 30.00 22.22 35.48 46.15 27.78 41.67 37.50 9.09 52.38	72,952 101,716 86,341 98,111 103,398 134,515 147,252 165,826 118,837 286,168 184,481 195,188 167,069 395,785 515,049 151,029 390,886
	TAX BILL	Negative Positive	18.04 11.05	252,739 131,215
	PARTICIPATION IN OCCUPATIONAL PENSION PLAN	Yes No	54.64 10.36	101,415 159,105
	MORTGAGE REPAYMENTS	Yes No	15.12 10.50	122,641 165,916
	LIFE INSURANCE CONTRIBUTIONS	Yes No	23.52 9.04	190,944 126,118

TABLE 5 . Results of the Tobit estimation for the general model

 5

	Page 51 of 83		Submitted Manuscript
		Coefficient	Marginal Effect	Std. Error	z-Statistic	Prob.
	C	-772944.2	-64292.13	108576.3	-7.118904	0.0000
	AGE AGE*AGE	22964.83 -259.8054	1910.17 -21.68	4915.381 54.84662	4.672035 -4.736945	0.0000 0.0000
	INCOME	0.042513	0.003514	0.005972	7.118444	0.0000
	INCOME*INCOME	-1.98E-09	-1,64693E-10	4.19E-10	-4.732125	0.0000
	SALARIED OCCUPATIONALP	-38574.77 172098.7	-43470.35 43790.72	16299.70 29915.47	-2.366595 5.752832	0.0180 0.0000
	EMPLOYERC	-0.483151	-0.040188	0.067742	-7.132190	0.0000
	PRIORC	1.290833	0.107369	0.050385	25.61938	0.0000
	MORTGAGE	-0.025753	-0.002142 Error Distribution 0.011719	-2.197532	0.0280
	SCALE:C(11)	159924.4		4444.289	35.98424	0.0000
	R-squared	0.534140	Mean dependent var			17725.07
	Adjusted R-squared	0.532602	S.D. dependent var			73299.59
	S.E. of regression	50112.37	Akaike info criterion			3.479154
	Sum squared resid	7.61E+12	Schwarz criterion			3.500930
	Log likelihood Avg. log likelihood	-5279.054 -1.735960	Hannan-Quinn criter.		3.486981
	Left censored obs	2683	Right censored obs			0
	Uncensored obs	358	Total obs			3041

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

TABLE A1 . Results of the Tobit estimation for the prudential model

 A1

		Coefficient	Std. Error	z-Statistic	Prob.
	C	-918664.1	108308.6	-8.481915	0.0000
	AGE	31463.59	4931.230	6.380475	0.0000
	AGE*AGE	-350.2904	54.97829	-6.371431	0.0000
	OCCUPATIONALP EMPLOYERC	190266.5 -0.475665	32070.75 0.070643	5.932709 -6.733330	0.0000 0.0000
	PRIORC	1.466353	0.044976	32.60324	0.0000
		Error Distribution
	SCALE:C(7)	168214.5	3625.361	46.39937	0.0000
	R-squared	0.502038 Mean dependent var		17725.07
	Adjusted R-squared	0.501053 S.D. dependent var		73299.59
	S.E. of regression	51776.03 Akaike info criterion		3.499670
	Sum squared resid Log likelihood	8.13E+12 Schwarz criterion -5314.248 Hannan-Quinn criter.		3.513527 3.504651
	Avg. log likelihood	-1.747533
	Left censored obs	2683	Right censored obs		0
	Uncensored obs	358	Total obs		3041

TABLE A2 . Results of the Tobit estimation for the tax planning model

 A2

		Submitted Manuscript
			Figure 1. Distribution of family assets.1984-2003
	100%
	30% 40% 50% 60% 70% 80% 90%	F o r P e e r R e v i e w
	20%
	10%
	0%
		Coefficient	Std. Error	z-Statistic	Prob.
	C	-574386.7	27999.27	-20.51434	0.0000
	INCOME	0.111300	0.008877	12.53834	0.0000
	INCOME*INCOME -4.10E-09 TAXBILL 0.045730	6.32E-10 0.019646	-6.490179 2.327738	0.0000 0.0199
	MORTGAGE	-0.071568	0.023655	-3.025521	0.0025
		Error Distribution
	SCALE:C(6)	266798.1	11630.07	22.94038	0.0000
	R-squared	0.208576 Mean dependent var		17725.07
	Adjusted R-squared	0.207272 S.D. dependent var		73299.59
	S.E. of regression	65262.49 Akaike info criterion		3.674403
	Sum squared resid Log likelihood	1.29E+13 Schwarz criterion -5580.930 Hannan-Quinn criter.		3.686280 3.678672
	Avg. log likelihood	-1.835228
	Left censored obs	2683	Right censored obs		0
	Uncensored obs	358	Total obs		3041
	Figure2. Ageand average i nvestmentin assets.

Page 52 of 83 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Age and average investment in different assets.

  2003

	Page 53 of 83					Submitted Manuscript Submitted Manuscript			Page 54 of 83
	Percentage Pesetas	F o r P e e r R e v i e w F o r P e e r R e v i e w Figure 2. 0 100,000 200,000 300,000 400,000 500,000 600,000 Figure 3.		Other Pension Funds Life insurance Investment funds Shares Bonds Deposits Mortgage repayments Pension plans Life insurance
		25	30	35	40	45	50	55	60	65
						Years Age

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Income levels and average investment in assets.

	Page 55 of 83						Submitted Manuscript
		1,000,000
		900,000
		800,000
		700,000
		600,000
	Pesetas	500,000		F o F o								Mortgage repayments Pension plans Life insurance
		400,000		r r
		300,000		P e P e
		200,000			e e
					r r
		100,000
		0	1	2	3	4 R e R e	5	6	7	8	9	10
						Deciles i v v i
						e w e w

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

  FollowingCabrer, Sancho, and Serrano (2001), the specification of the model is as follow3 . The regressand Y i can take a value of zero or the value of the variable *

	i Y , known
	as the latent variable:
	F o
	r
	P e
	e
	r
	paper. What variables influence the decision to invest in a personal pension plan? And, R e what variables affect the amount individuals decide to contribute to their pension plans? v i To answer these questions, we shall specify and estimate a Tobit model for a 1995 sample (the latest available) from the Institute of Fiscal Studies Personal Income Taxpayers Panel. e w
	The sample is formed by 3,041 tax returns, of which 358 include contributions to personal
	pension plans.

Table 4 ,

 4 meanwhile, reflects the percentage of personal pension plan contributors for each variable, as well as the average contributions made. As the first row of this table shows, 11.77 percent of 1995 tax returns

	F o
	r
	P e
	e
	r
	R e
	v i
	e w

  individuals invest in pension plans basically to save against their retirement, perhaps as a supplement to other retirement funds obtained from sources such as the social security or life insurance. The explanatory variables in this model are age, marital status, occupation, membership of an occupational pension plan, employer's contributions, prior contributions, mortgage repayments and contributions to life insurance. The specification of the model is as follows:

	1 PLAN =	f	, ENTREPRENE MORTGAGE PRIORC , UR STATUS , EMPLOYERC , , ( AGE C	, ,	) PROFESSION INSURANCE AL	,	SALARIED	,	OCCUPATION	ALP	,	[12]
			F o
			r
			P e
				e
					r
					R e
							v i
							e w

TABLE 1 . Pension plan IRR, 1987-2004

 1 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

	Period							IRR								g
																	1
	1987-1991	IRR P.87 =	1 (	+	i	)•	1 1 (	d g	q t	e	)	j	x	1	0.98
																	1
	1992-1998	IRR P.92 =	1 (	+	i	)•	1 1 (	t g	px t	e	)	j	x	1	0.95 or 1
	1999 and thereafter	IRR P.99 =	1 (	+	i	)•	1 (	1	t g	px t	pj	)	j	1	x	1	0.6 (if j-x>2)

TABLE 2 . Tax treatment of pension plans

 2

			Submitted Manuscript
			1987 -1991	1992 -1998		1999 -2004
	CONTRIBUTIONS
	Personal Income Tax saving	tpx or 15%	tpx			tpx
						Up to 52 years	> 52 years
					In 1999:	Ptas. 1,100,000	----
	Limits on				In 2000-01: Ptas. 1,200,000	2000-01:+ Ptas. 100,000 (age-52)
	allowances and	--Absolute	Ptas. 500,000 -750,000	Ptas. 750,000 -1,100,000	In 2002:	Ptas. 1,200,000	In 2002:+ Ptas. 200,000 (age-52)
	tax credits				Since 2003: € 8,000	Since 2003: + €1,250 (age-52)
		--Relative	15% earned income	15%-20% earned income	100% general taxable income	100% general taxable income
					(In 1999-01: 20%, 25%)	(In 1999-01: 20%, 25%, 40%)
	ACCUMULATION
	Corporate Income Tax			Zero rate
	Net Wealth Tax		Not subject	Exempt			Exempt
	BENEFITS
	Personal Income Tax base	Final capital	Final capital		Final capital
	Taxable returns		98%	95% -100%			60%
	Applicable tax rate		te	te			tpj
	Source: Own work.

Page 76 of 83 Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

TABLE 4 . Personal pension plan membership and average contributions

 4

	VARIABLE		PERCENTAGE CONTRIBUTORS	AVERAGE CONTRIBUTION (pesetas)
	TOTAL		11.77	150,564
	AGE	20-25 25-30 30-35 35-40 40-45 45-50 50-55 55-60 60-65	3.33 4.03 9.52 11.82 15.99 20.23 16.03 9.05 6.60	76,100 71,294 107,387 143,148 157,821 168,435 162,782 182,430 213,851
	MARITAL STATUS	Unmarried Married	10.30 13.12	123,855 169,825
	INCOME LEVEL	Decile 1 Decile 2 Decile 3 Decile 4 Decile 5 Decile 6 Decile 7 Decile 8 Decile 9 Decile 10	2.63 3.95 5.59 6.25 7.57 10.53 11.18 15.13 21.38 33.55	50,323 82,919 81,680 88,752 94,569 116,845 92,666 106,532 152,520 250,495
	OCCUPATION	Entrepreneur Professional Salaried employee	11.52 21.30 11.74	156,509 212,584 147,810
	MARGINAL TAX RATE	0.0% 20.0% 22.0% 24.5% 27.0% 30.0% 32.0% 34.0% 36.0% 38.0% 40.0% 42.5% 45.0% 47.0% 49.0% 51.0% 53.5%	3.65 4.51 6.24 8.73 12.23 17.54 19.77 23.30 30.00 22.22 35.48 46.15 27.78 41.67 37.50 9.09 52.38	72,952 101,716 86,341 98,111 103,398 134,515 147,252 165,826 118,837 286,168 184,481 195,188 167,069 395,785 515,049 151,029 390,886
	TAX BILL	Negative Positive	18.04 11.05	252,739 131,215
	PARTICIPATION IN OCCUPATIONAL PENSION PLAN	Yes No	54.64 10.36	101,415 159,105
	MORTGAGE REPAYMENTS	Yes No	15.12 10.50	122,641 165,916
	LIFE INSURANCE CONTRIBUTIONS	Yes No	23.52 9.04	190,944 126,118

TABLE 5 . Results of the Tobit estimation for the general model

 5

	Page 79 of 83		Submitted Manuscript
		Coefficient	Marginal Effect	Std. Error	z-Statistic	Prob.
	C	-772944.2	-64292.13	108576.3	-7.118904	0.0000
	AGE AGE*AGE	22964.83 -259.8054	1910.17 -21.68	4915.381 54.84662	4.672035 -4.736945	0.0000 0.0000
	INCOME	0.042513	0.003514	0.005972	7.118444	0.0000
	INCOME*INCOME	-1.98E-09	-1,64693E-10	4.19E-10	-4.732125	0.0000
	SALARIED OCCUPATIONALP	-38574.77 172098.7	-43470.35 43790.72	16299.70 29915.47	-2.366595 5.752832	0.0180 0.0000
	EMPLOYERC	-0.483151	-0.040188	0.067742	-7.132190	0.0000
	PRIORC	1.290833	0.107369	0.050385	25.61938	0.0000
	MORTGAGE	-0.025753	-0.002142 Error Distribution 0.011719	-2.197532	0.0280
	SCALE:C(11)	159924.4		4444.289	35.98424	0.0000
	R-squared	0.534140	Mean dependent var			17725.07
	Adjusted R-squared	0.532602	S.D. dependent var			73299.59
	S.E. of regression	50112.37	Akaike info criterion			3.479154
	Sum squared resid	7.61E+12	Schwarz criterion			3.500930
	Log likelihood Avg. log likelihood	-5279.054 -1.735960	Hannan-Quinn criter.		3.486981
	Left censored obs	2683	Right censored obs			0
	Uncensored obs	358	Total obs			3041

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Age and average investment in different assets.

  2003

	Page 81 of 83					Submitted Manuscript Submitted Manuscript			Page 82 of 83
	Percentage Pesetas	F o r P e e r R e v i e w F o r P e e r R e v i e w Figure 2. 0 100,000 200,000 300,000 400,000 500,000 600,000 Figure 3.		Other Pension Funds Life insurance Investment funds Shares Bonds Deposits Mortgage repayments Pension plans Life insurance
		25	30	35	40	45	50	55	60	65
						Years Age

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Income levels and average investment in assets.

	Page 83 of 83
		1,000,000
		900,000
		800,000
		700,000
		600,000
	Pesetas	500,000									Mortgage repayments Pension plans Life insurance
		400,000
		300,000
		200,000
		100,000
		0
		1	2	3	4	5	6	7	8	9	10
						Deciles

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK

Submitted Manuscript

See also, Wooldridge (2003).

See, for example,Guariglia and Markose (2000),Joulfaian and Richardson (2001), andEngelhardt and Madrian (2004) We have not been able to use the number of children, because this variable was not reliable in the sample.

Following the Spanish Tax Agency -Agencia Estatal de Administración Tributaria-9 percent of 1995 tax returns declared contributions to some kind of pension plan, the average amount of which was 184,150 pesetas. According to data from the Dirección General de Seguros y Fondos dePensiones, 1,423,542 people contributed to

The authors would like to thank José María Labeaga and Llorenç Pou for their helpful comments and suggestions, and the Institute for Fiscal Studies and Ministry of Science and Technology (project SEC2003-05784/ECO) for the funding received.

Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript Editorial Office, Dept of Economics, Warwick University, Coventry CV4 7AL, UK Submitted Manuscript