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Taxable and Tax-Deferred Investing: A Tax-Arbitrage Approach

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  • Jennifer Huang

Abstract

We analyze an intertemporal portfolio problem with both taxable and tax-deferred retirement accounts. Using a tax-arbitrage argument, we identify conditions under which the optimal location decision (where to place an asset) is separable from the allocation decision (how much to allocate to each asset). Investors place highly taxed assets in the tax-deferred account to maximize the tax benefit and adjust their taxable portfolios to achieve the optimal risk exposure. We show that the two-account problem can be reduced to a taxable-account-only problem. The results are robust to capital gains tax deferrals, consumption and contribution decisions, and stochastic tax rates. The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org, Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 21 (2008)
Issue (Month): 5 (September)
Pages: 2173-2207

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Handle: RePEc:oup:rfinst:v:21:y:2008:i:5:p:2173-2207

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Cited by:
  1. Rydqvist, Kristian & Schwartz, Steven T. & Spizman, Joshua D., 2014. "The tax benefit of income smoothing," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 78-88.
  2. Rydqvist, Kristian & Spizman, Joshua & Strebulaev, Ilya, 2011. "The evolution of aggregate stock ownership," CFS Working Paper Series 2011/18, Center for Financial Studies (CFS).
  3. Frank Seifried, 2010. "Optimal investment with deferred capital gains taxes," Computational Statistics, Springer, vol. 71(1), pages 181-199, February.
  4. Damiaan H.J. Chen & Roel Beetsma & Eduard Ponds & Ward E. Romp, 2014. "Intergenerational Risk-Sharing through Funded Pensions and Public Debt," CESifo Working Paper Series 4624, CESifo Group Munich.
  5. Clemens Sialm & Laura Starks, 2009. "Mutual Fund Tax Clienteles," NBER Working Papers 15327, National Bureau of Economic Research, Inc.
  6. Katarzyna Romaniuk, 2013. "Pension fund taxation and risk-taking: should we switch from the EET to the TEE regime?," Annals of Finance, Springer, vol. 9(4), pages 573-588, November.
  7. Zhou, Jie, 2009. "The asset location puzzle: Taxes matter," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 955-969, April.
  8. Rydqvist, Kristian & Schwartz, Steven & Spizman, Joshua, 2011. "The Tax Benefit of Income Smoothing," CEPR Discussion Papers 8425, C.E.P.R. Discussion Papers.
  9. Zhou, Jie, 2012. "Life-cycle stock market participation in taxable and tax-deferred accounts," Journal of Economic Dynamics and Control, Elsevier, vol. 36(11), pages 1814-1829.
  10. Kristian Rydqvist & Joshua Spizman & Ilya A. Strebulaev, 2011. "Government Policy and Ownership of Financial Assets," NBER Working Papers 17522, National Bureau of Economic Research, Inc.
  11. Marekwica, Marcel, 2012. "Optimal tax-timing and asset allocation when tax rebates on capital losses are limited," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2048-2063.
  12. Clemens Sialm, 2009. "Tax Changes and Asset Pricing," American Economic Review, American Economic Association, vol. 99(4), pages 1356-83, September.

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