Retirement Savings and Portfolio Choices in Taxable and Tax-Deferred Accounts

This study attempts to explain the observed asset allocation and location decisions for households making taxable and tax-deferred investment. I incorporate employer matching policies and other pension account characteristics into a life-cycle model of optimal intertemporal consumption and portfolio choice, which includes a taxable saving account and a tax-deferred retirement saving account. The model is estimated using data from the Surveys of Consumer Finances (1992 to 2007), and the structural parameters are recovered by the Method of Simulated Moments. After modeling the features of U.S. pension system, the predicted policy rules are able to explain the observed portfolio patterns of American households, who are more likely to hold equities in the tax-deferred pension account. The estimates and results show that employer matching induces higher proportion of total wealth held in the pension account, so investors tend to boost equity investments in the taxdeferred account to enjoy the higher returns and reduce equity holdings in the taxable account for precautionary saving purpose. I find that an increase of 10 percent in employer match rate makes investors boost the average equity proportion in the pension account by 10 percent and reduce those holdings in the taxable account by 22 percent. In contrast, since the employer stock match exposes the households to a riskier situation in the pension account than the cash match, it causes households voluntarily to hold less equity in that account, resulting in an average decrease of 4 percent in the equity ownership and 3 percent in the conditional equity proportion. Moreover, the policy experiment reveals that a deletion of Social Security taxes and payments makes the pension account the only source of retirement income, so households tend to put a higher proportion of savings in the tax-deferred account, and they are likely to invest conservatively and hold about 25 percent more of pension wealth in relatively safe assets.