Portfolio Allocation Choices in Taxable and Tax-Deferred Accounts: An Empirical Analysis of Tax-Efficiency

Tax efficiency is the dominant consideration in theoretical portfolio models that allow for both taxable and tax-deferred accounts. Yet, empirically observed portfolio allocations are not tax-efficient. I offer a model that is designed to bridge the existing gap and validate its predictions on household-level portfolio data from the Survey of Consumer Finances. The model explicitly incorporates both the uninsurable risk in labor income and accessibility restrictions that are an institutional feature of tax-deferred retirement accounts. Together, these elements create a tension between the desire to maintain tax-efficient allocations and one's concern over the need to make costly withdrawals from retirement accounts in the event of bad income draws. This leads some low-wealth households and households facing the highest penalties on withdrawals to forgo tax-efficient allocations in favor of allocations that provide more liquidity. The empirical results provide evidence that both the choice of a tax-inefficient portfolio and heterogeneity in portfolio allocations are related to the presence and severity of accessibility restrictions and precautionary motives.