Asset Allocation Over the Life Cycle: How Much Do Taxes Matter?

54 Pages Posted: 26 Sep 2010 Last revised: 17 May 2013

See all articles by Holger Kraft

Holger Kraft

Goethe University Frankfurt

Marcel Fischer

Copenhagen Business School

Claus Munk

Copenhagen Business School

Date Written: January 21, 2012

Abstract

We study the welfare effect of tax-optimizing portfolio decisions in a life cycle model with unspanned labor income and realization-based capital gain taxation. For realistic parameterizations of our model, certainty equivalent welfare gains from fully tax-optimized portfolio decisions are less than 2% of present financial wealth and lifetime income compared to a heuristic portfolio policy ignoring the taxation of profits (capital gains, interest and dividend payments). Compared to a heuristic portfolio policy that only ignores the realization-based feature of capital gain taxation and instead assumes mark-to-market taxation, these gains are less than 0.5%. However, if capital gains are forgiven at death (as in the U.S.), investors with strong bequest motives face substantial welfare costs when not tax-optimizing their portfolio decisions towards the end of the life cycle.

Keywords: Portfolio Choice, Life Cycle Asset Allocation, Taxation, Unspanned Labor Income

JEL Classification: G11, H24

Suggested Citation

Kraft, Holger and Fischer, Marcel and Munk, Claus, Asset Allocation Over the Life Cycle: How Much Do Taxes Matter? (January 21, 2012). Journal of Economic Dynamics and Control, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1682645 or http://dx.doi.org/10.2139/ssrn.1682645

Holger Kraft (Contact Author)

Goethe University Frankfurt ( email )

Faculty of Economics and Business Administration
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Marcel Fischer

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45-3815-3628 (Phone)

Claus Munk

Copenhagen Business School ( email )

Department of Finance
Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

HOME PAGE: http://sites.google.com/view/clausmunk/home

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