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Asset Location for Retirement Savers

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  • James M. Poterba
  • John B. Shoven
  • Clemens Sialm

Abstract

This paper uses data on actual returns on taxable bonds, tax-exempt bonds, and a small sample of equity mutual funds over the 1962-1998 period to compare two asset location strategies for retirement savers. The first strategy gives priority to holding equities, through equity mutual funds, in a saver's tax-deferred account, while the second strategy gives priority to holding fixed-income investments in the tax-deferred account. We consider high-income taxable individual investors who saved in each year and invested in one of actively-managed funds in our sample. Over the thirty-seven year span that we consider, such savers would have accumulated a larger stock of wealth if they had held their equity mutual fund in their tax-deferred account than if they had held the fund in a conventional taxable form. The explanation for this apparent contradiction of the often-stated bonds in the tax-deferred account' prescription has two parts. First, many equity mutual funds impose substantial tax burdens on their investors. This raises the effective tax rate on investing in equities through mutual funds rather than in a buy-and-hold personal portfolio. Second, taxable investors who wish to hold fixed income assets can do so by holding tax-exempt bonds as well as by holding taxable bonds. The interest rate differential between taxable and tax-exempt bonds suggests that the effective tax rate on fixed income investments may be lower than the statutory tax rate for high-income investors.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7991.

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Date of creation: Nov 2000
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Publication status: published as Gale, W., J. Shoven, and M. Warshawsky (eds.) Public Policies and Private Pensions. Washington: Brookings Institution, 2004.
Handle: RePEc:nbr:nberwo:7991

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  1. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, American Finance Association, vol. 36(1), pages 1-13, March.
  2. John B. Shoven & Joel Dickson & Clemens Sialm, 2000. "Tax Externalities of Equity Mutual Funds," NBER Working Papers 7669, National Bureau of Economic Research, Inc.
  3. John B. Shoven & Clemens Sialm, 1999. "Asset Location in Tax-Deferred and Conventional Savings Accounts," NBER Working Papers 7192, National Bureau of Economic Research, Inc.
  4. Poterba, J.M., 1989. "Tax Reform And The Market For Tax-Exempt Debt," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 514, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
  6. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  7. John B. Shoven, 1999. "The Location and Allocation of Assets in Pension and Conventional Savings Accounts," NBER Working Papers 7007, National Bureau of Economic Research, Inc.
  8. Joel M. Dickson & John B. Shoven, 1995. "Taxation and Mutual Funds: An Investor Perspective," NBER Chapters, in: Tax Policy and the Economy, Volume 9, pages 151-180 National Bureau of Economic Research, Inc.
  9. Daniel Bergstresser & James Poterba, 2000. "Do After-Tax Returns Affect Mutual Fund Inflows?," NBER Working Papers 7595, National Bureau of Economic Research, Inc.
  10. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, American Finance Association, vol. 52(1), pages 57-82, March.
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Cited by:
  1. Christine Lai, 2006. "Determinants of Portfolio Efficiency Losses in US Self-directed Pension Accounts," Journal of Family and Economic Issues, Springer, Springer, vol. 27(4), pages 601-625, December.
  2. Shoven, John B. & Sialm, Clemens, 2004. "Asset location in tax-deferred and conventional savings accounts," Journal of Public Economics, Elsevier, Elsevier, vol. 88(1-2), pages 23-38, January.
  3. Milevsky, Moshe Arye & Panyagometh, Kamphol, 2001. "Variable annuities versus mutual funds: a Monte-Carlo analysis of the options," Financial Services Review, Elsevier, Elsevier, vol. 10(1-4), pages 145-161.
  4. Amromin, Gene & Huang, Jennifer & Sialm, Clemens, 2007. "The tradeoff between mortgage prepayments and tax-deferred retirement savings," Journal of Public Economics, Elsevier, Elsevier, vol. 91(10), pages 2014-2040, November.
  5. Bergstresser, Daniel & Poterba, James, 2004. "Asset allocation and asset location: household evidence from the survey of consumer finances," Journal of Public Economics, Elsevier, Elsevier, vol. 88(9-10), pages 1893-1915, August.
  6. Zhou, Jie, 2009. "The asset location puzzle: Taxes matter," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 33(4), pages 955-969, April.
  7. Gary V. Engelhardt & Anil Kumar, 2007. "Employer matching and 401(k) saving: Evidence from the health and retirement study," NBER Chapters, in: Trans-Atlantic Public Economics Seminar (TAPES), Public Policy and Retirement, pages 1920-1943 National Bureau of Economic Research, Inc.
  8. Gopi Shah Goda & Colleen Flaherty Manchester, 2013. "Incorporating Employee Heterogeneity into Default Rules for Retirement Plan Selection," Journal of Human Resources, University of Wisconsin Press, vol. 48(1), pages 198-235.
  9. Gene Amromin, 2008. "Precautionary Savings Motives and Tax Efficiency of Household Portfolios: An Empirical Analysis," NBER Chapters, in: Tax Policy and the Economy, Volume 22, pages 5-41 National Bureau of Economic Research, Inc.
  10. Burman, Leonard E. & Gale, William G. & Weiner, David, 2001. "The Taxation of Retirement Saving: Choosing Between Front-Loaded and Back-Loaded Options," National Tax Journal, National Tax Association, vol. 54(n. 3), pages 689-702, September.
  11. Richard Johnson, 2003. "Portfolio choice in tax-deferred and Roth-type savings accounts," Research Working Paper, Federal Reserve Bank of Kansas City RWP 03-08, Federal Reserve Bank of Kansas City.
  12. Garlappi, Lorenzo & Huang, Jennifer, 2006. "Are stocks desirable in tax-deferred accounts?," Journal of Public Economics, Elsevier, Elsevier, vol. 90(12), pages 2257-2283, December.
  13. Gene Amromin, 2005. "Precautionary savings motives and tax efficiency of household portfolios: an empirical analysis," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2005-01, Board of Governors of the Federal Reserve System (U.S.).
  14. Cunningham, Christopher R. & Engelhardt, Gary V., 2002. "Federal Tax Policy, Employer Matching, and 401(k) Saving: Evidence from HRS W-2 Records," National Tax Journal, National Tax Association, vol. 55(3), pages 617-45, September.

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