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Asset Location for Retirement Savers

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

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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File URL: http://www.nber.org/papers/w7991.pdf
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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
Note: AG AP PE
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  1. James M. Poterba, 1989. "Tax Reform and the Market For Tax-Exempt Debt," NBER Working Papers 2900, National Bureau of Economic Research, Inc.
  2. Tepper, Irwin, 1981. "Taxation and Corporate Pension Policy," Journal of Finance, American Finance Association, vol. 36(1), pages 1-13, March.
  3. Bergstresser, Daniel & Poterba, James, 2002. "Do after-tax returns affect mutual fund inflows?," Journal of Financial Economics, Elsevier, vol. 63(3), pages 381-414, March.
  4. John B. Shoven & Joel Dickson & Clemens Sialm, 2000. "Tax Externalities of Equity Mutual Funds," NBER Working Papers 7669, National Bureau of Economic Research, Inc.
  5. Irwin Tepper, 1981. "Taxation and Corporate Pension Policy," NBER Working Papers 0661, National Bureau of Economic Research, Inc.
  6. 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.
  7. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  8. 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.
  9. 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.
  10. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
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