A Reduced-Form Approach to Retirement Planning under Constraints

We analyze the intertemporal portfolio problem of an investor who has access to both taxable and tax-deferred (retirement) accounts and is subject to borrowing and short-selling constraints. We provide conditions under which the commonly used location rule of preferring higher-taxed assets in the tax-deferred account might not be optimal. We also derive analytical solutions for the optimal portfolio allocation by transforming the two-account problem into a mixture of two single-account problems (one with only a taxable account and one with only a tax-deferred account). For financial planning purposes, we derive convenient “rules of thumb” to approximate our theoretical results and assess the performance of the rules using numerical methods.