Taxable or tax–deferred investing: A tax-arbitrage approach, Working paper

We analyze an intertemporal portfolio problem with both taxable and tax-deferred retire-ment 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 de-cision (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. (JEL G11) Tax-deferred retirement accounts have grown considerably in popularity in recent years. An investor with significant wealth in both his taxable and tax-deferred accounts faces both the traditional asset allocation decision (how much to allocate to each asset) and a location decision (where to place an asset). When dealing with each account in isolation, the investor’s desired allocation is generally different across the two accounts, as he prefers different portfolios under different tax environments.1 Integrating the two portfolio decisions is clearly important and, not surprisingly, complex, given the potential interactions between these decisions and tax considerations.2 This paper seeks to shed ligh