Tax Uncertainty and Retirement Savings Diversification

51 Pages Posted: 23 Jun 2016 Last revised: 19 Nov 2016

David C. Brown

University of Arizona - Department of Finance

Scott Cederburg

University of Arizona - Department of Finance

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance

Date Written: November 10, 2016

Abstract

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

Brown, David C. and Cederburg, Scott and O'Doherty, Michael S., Tax Uncertainty and Retirement Savings Diversification (November 10, 2016). Available at SSRN: https://ssrn.com/abstract=2799288

David C. Brown

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States
520-626-0746 (Phone)

HOME PAGE: http://www.davidclaytonbrown.com

Scott Cederburg (Contact Author)

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance ( email )

Robert J. Trulaske, Sr. College of Business
403 Cornell Hall
Columbia, MO 65211
United States

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