Taxes on withdrawals from tax-deferred accounts like IRAs cause "tax drift," distorting intended asset allocations, exceeding traditional rebalancing ranges. Tax-adjusted allocation strategies can align portfolios with risk–return goals.
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Abstract
Spending from tax-deferred accounts like IRAs incurs taxes. These taxes induce deviations between the intended and the effective asset allocations: A dollar on a portfolio statement is not necessarily a dollar when evaluating the asset allocation. This drift can be larger than traditional rebalancing ranges. Investors underestimate the size of this tax-induced asset allocation drift at their peril. Investors should recognize the tax-induced asset allocation drift and adopt tax-adjusted asset allocation in consequence.