Taxable and Tax-Deferred Investing with the Limited Use of Losses

Abstract

We study the impact of the different tax treatment of capital gains and losses on the optimal location of assets in taxable and tax-deferred accounts. The classical result of Black (1980) and Tepper (1981) suggests that investors should follow a strict pecking-order asset location rule and hold those assets that are subject to the highest tax rate preferentially in tax-deferred accounts. We show that with the different tax treatment of realized gains and losses, only tax-efficient equity mutual funds are optimally held in taxable accounts whereas mutual funds with average tax-(in)efficiency are preferentially * We would like to thank

Tax-Preferred Savings Vehicles: Can Financial Education Improve Asset Location Decisions?

“…1 We investigate two tax-preferred investment accounts that differ in terms of whether taxes are back-or front-loaded (Yoo and de Serres, 2004). In back-loaded or EET accounts, individuals contribute pre-tax income (exempt, E), their investment returns are tax-exempt in the year in which they are generated (E), and they pay income tax at the 1 Finding the best tax-preferred savings vehicle is a problem that is as relevant as finding the best asset allocation across tax-preferred and taxable accounts (Ameriks and Zeldes, 2004, Bergstresser and Poterba, 2004, Fisher and Gallmeyer, 2017 and the efficiency of the savings instruments they used Amromin (2003). time of withdrawal (taxed, T).…”