Are tax-deferred investments invariably superior?
Financial institutions that are marketing tax-sheltered plans claim that the implied rates of return of tax-sheltered strategies are superior to those rates of return realized from taxable plans. The purpose of our paper is to investigate that claim. To accomplish our purpose, we have developed a model to determine, under different assumptions of various tax rates, the incremental benefits and the implied rates of returns of tax-deferred investments over the taxable investments. When the model is applied, the results show that tax-deferred investments are not always superior. Consequently, investors may not have a choice but to select portfolios at the lower end of the efficient frontier.
