Journal Article

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

Jennifer Huang

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 21, issue 5, pages 2173-2207
Published in print September 2008 | ISSN: 0893-9454
Published online June 2008 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhn064
Taxable and Tax-Deferred Investing: A Tax-Arbitrage Approach

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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.

Keywords: G11

Journal Article.  17030 words.  Illustrated.

Subjects: Economics

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