Portfolio Choice in Tax-Deferred and Roth-Type Savings Accounts

By Richard Johnson
September 2003 
RWP 03-08
Research Division 
Federal Reserve Bank of Kansas City 

Abstract

      This paper uses numerical methods to compare optimal portfolios in tax-deferred and Roth-type savings accounts. Income and payroll taxes affect optimal portfolios in tax-deferred and Roth-type plans differently. For workers with assets in only one type of plan, the optimal equity share in a tax-deferred account could be higher or lower than in a Roth, depending on initial wealth. The differences in optimal portfolios between plans are large at short investment horizons but smaller at longer horizons. This paper also studies the 'asset location' decision of workers with assets in plans of both types.

Keywords: portfolio choice, retirement saving, individual retirement accounts (IRAs), 401K accounts, and Roth IRAs

JEL Codes: G11, G23, H24

Richard Johnson is an economist at the Federal Reserve Bank of Kansas City. The author would like to thank Jim Poterba, Luis Viceira and Ryan George for their advice and comments and Thomas Schwartz for excellent research assistance. The views expressed herein are those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or of the Federal Reserve System.

Johnson e-mail:  Richard.Johnson@kc.frb.org

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