Tax Uncertainty and Retirement Savings Diversification
51 Pages Posted: 23 Jun 2016 Last revised: 19 Nov 2016
Date Written: November 10, 2016
We investigate the optimal savings decisions for investors with access to pre-tax (traditional) and post-tax (Roth) versions of tax-advantaged retirement accounts. The model features a progressive tax schedule and uncertainty over future tax rates. Traditional accounts are valuable for hedging retirement account performance and managing current income near tax-bracket cutoffs, whereas Roth accounts allow investors to mitigate uncertainty over future tax schedules. The optimal asset location policy for most households involves diversifying between traditional and Roth vehicles. Contrary to conventional advice, the substantial economic benefits from Roth investments are not limited to investors with low current income.
Keywords: Tax Uncertainty, Asset Location, Retirement Savings, IRA, Roth
JEL Classification: G11, H31, J32
Suggested Citation: Suggested Citation