Kentucky Windage for Asset Allocation
Author(s): William W. Jennings, Brian C. Payne
Topics:
- After-Tax Allocation
Year Published: 2022
My Rating: TBD
One Sentence Summary: The paper provides simple adjustments one can make to their asset allocation to adjust for the embedded tax liability of a pre-tax IRA.
Summary
Taxes reduce the value of investments in tax-advantaged accounts, creating a discrepancy between pre-tax and after-tax asset allocation. To correct for this, a “Kentucky windage” adjustment increases the pre-tax bond allocation by a percentage determined by tax rate, IRA size, and stock/bond mix. This ensures the after-tax asset allocation aligns with the intended target, mitigating the risk of holding a portfolio with a higher than expected stock allocation.
Note: I believe that after-tax asset allocation attempts to solve a problem that doesn’t exist. There’s no reason to treat taxes in some special way over and above any other expense that we have. The fact that the amount and timing of tax liability is based on the amount and timing of a distribution from pre-tax or taxable accounts doesn’t change this.
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