The following investment calculations will help you prepare for your retirement, and help you determine how much money you will need at retirement, and what steps you need to take to get there.
- Use future or present value techniques to solve the following problems:
(Note: You can use tables or a financial calculator. If you use a calculator, please provide the inputs you used to solve the problems)
a. Starting with $20,000, how much will you have in 20 years if you can earn five percent on your money?
b. If you inherited $100,000 today and invested all of it in a security that paid a eight percent rate of return, how much would you have in 15 years?
c. If the average new home costs $200,000 today, what will be the value in 10 years if inflation is four percent per year?
d. If you can earn nine percent per year, how much will you have to save each year if you want to retire in 40 years with $3 million?
Answers:
a. TVM Calc:
N= 20
I= 5
PV= -20000
PMT= 0
FV= $53,065.95
Answer: $53,065.95
b. TVM Calc:
N= 15
I= 8
PV= -100000
PMT= 0
FV= $317,216.91
Answer: $317,216.91
c. TVM Calc:
N= 10
I= 4
PV= -200000
PMT= 0
FV= $296,048.86
Answer: $296,048.86
d. TVM Calc:
N= 40
I= 9
PV= 0
PMT= -$8,878.83
FV= 3000000
Answer: I would need to save $8,878.83 each year.
—————————————————————————-
- Construct a balance sheet for the Jones family from the following information. Be sure the format is correct. Is the Jones family solvent or insolvent? Yes, No? Explain.
Cash on hand 500
Bank credit card balance 5,000
Auto loan balance 20,000
Mortgage 150,000
Primary residence (FMV) 225,000
Jewelry 1,000
Stocks 10,000
Stamp collection 1,500
2010 Acura 20,000
Answer:
ASSETS:
Liquid Assets:
Cash on hand $500
Total Liquid Assets $500
Investments:
Stocks $10,000
Total Investments $10,000
Real Property:
Primary residence (FMV) $225,000
Total Real Property $225,000
Personal Property:
2010 Acura $20,000
Stamp collection 1,500
Jewelry 1,000
Total Personal Property $22,500
Total Assets $258,000
—————————————-
LIABILITIES AND NET WORTH:
Current Liabilities:
Bank credit card balance $5,000
Total Current Liabilities $5,000
Long-Term Liabilities:
Mortgage $150,000
Auto loan balance 20,000
Total Long-Term Liabilities $170,000
Total Liabilities $175,000
—————————————-
Net Worth $83,000 (258,000-175,000)
Total Liabilities and Net Worth $258,000
The Jones family is solvent, as their net worth is $83,000, which is more than zero. This shows a presence of financial planning, and that the family has planned their finances well. They have a paid for car, and owe less on their mortgage than the house is worth, which is a good sign.
—————————————————————————-
- Part 1 – The Smith family would like to itemize their deductions for the current tax year. Their Adjusted Gross Income (AGI) is $85,000. Their filing status is Married Filing Jointly. Looking at the items below, which ones can they itemize and what is the total they can take on their Schedule A Itemized Deductions? Show all of your work to obtain full credit.
Part 2 – Assuming that the Smith’s Standard Deduction would be $11,400 for this tax year and that they are in the 25 percent marginal federal income tax bracket, how much does itemizing save their family in taxes?
Medical Expenses 5,000
State Income Taxes Paid 5,000
Real Estate Taxes 4,000
Home Mortgage Interest Paid 10,000
Gifts to Charity 2,000
Credit Card Interest 1,000
Unreimbursed Employee Expenses 2,000
Answer:
Part 1:
Adjusted Gross Income (AGI) $85,000
Medical Expenses 5,000 (85000*.075=6375); the Smith family can not deduct any medical expenses since the total amount does not exceed 7.5% of their AGI.
State Income Taxes Paid 5,000 – line #5, state income taxes are deductible
.
Real Estate Taxes 4,000 – line #6, personal property tax is deductible.
Home Mortgage Interest Paid 10,000 – line #10 home mortgage interest reported on form 1098 is deductible
Gifts to Charity 2,000 – line #16, Since they earn under the restricted AGI, they qualify for 50% deduction on these gifts to charity, as long as they have all their receipts and can prove the money was given; so $1,000 is deductible.
Credit Card Interest 1,000 – this is not deductible.
Unreimbursed Employee Expenses 2,000 – line #21 – you can deduct in excess of 2% of AGI; 85000*.02=1700; 2000-1700. they can deduct $300
Total they can take on their Schedule A Itemized Deductions: $5000+4000+10000+1000+300=$20,300
Part 2:
Assuming a standard $11,400 deduction, they would save $8900 more (20300-11400) by using itemized deductions. Since they are in the 25% bracket, this would save the family .25*8900 = $2,225.
—————————————————————————-
- Alan and Barbara are in the process of purchasing their first home. However, they cannot decide whether a 15-year fixed rate mortgage or a 30-year fixed rate mortgage is best for them. They have decided to finance $200,000 and can get the 15-year mortgage at 4.5 percent and the 30-year mortgage at 5 percent.
First of all, calculate the monthly payment of each loan. Next, discuss the pros and cons of a 15-year mortgage versus a 30-year mortgage.
Answer:
15-year mortgage:
TVM Calc:
N= 15
I= 4.5
PV= -200000
PMT= 18,622.76
FV= 0
Answer: 18622.76/12 = $1551.90/mo payment.
30-year mortgage:
TVM Calc:
N= 30
I= 5
PV= -200000
PMT= 13,010.29
FV= 0
Answer: 13,010.29/12= $1084.19/mo payment.
If you can afford it, the clear winner is the 15 year mortgage, simply because you will pay far less interest over the course of the loan, and have the loan paid off twice as quickly. For example, the total money paid for the 15 year mortgage is $279,342, or $79,342 of interest (1551.90*180 mo), and the total money paid for the 30 year mortgage is $390,308.40, or $190,308.40 (1084.19*360 mo). They will save $110,966.40 over the course of the loan by going the 15-year mortgage route. This money can be used to help the family retire. However, the family needs to go over their monthly expenses to see if they can swing the additional $467/month. The family will need to discuss whether their short term goals (having a little extra money every month) is worth sacrificing $110,966 over 30 years. However, if the couple goes the 30-year route, and invests the additional $467/month for 15 years, assuming 8% interest earned, the couple would have a total future value: $163.318. However, an 8% APY is not guaranteed, while the $110,966 savings by choosing the 15-year over the 30-year mortgage is certain.
—————————————————————————-
- John Jones is married with son, and would like to purchase enough life insurance to provide the following for his family:
Pay off home mortgage $200,000
Pay off car loan 20,000
Final burial expenses 10,000
College education for his son 60,000
Annual living expenses for his family 60,000/year for 20 years
If he were to die, his son and wife would receive $14,400 annually for 12 years from Social Security. His wife is also the primary beneficiary of his $100,000 group life policy. Given this information, how much more life insurance does John need? Additionally, John would like to keep his cash outlay as low as possible and the insurance policy that he purchases to last only 20 years. What type of insurance policy would you recommend?
Answer:
Total money needed: 200000+20000+10000+60000+(60000*20=1,200,000) = $1,490,000 total benefit needed.
However, he can already expect 14,400*12 = $172,800 from social security, and $100,000 from his group life policy, which equals a total of $272,800.
Subtract $272,800 expected benefit minus the $1,490,000 total benefit needed, and John will need an additional $1,217,200 of additional life insurance.
Since John wants to spend as little as possible on the policy and have it last only 20 years, he should choose a 20-year term life insurance policy. This way, the amount of John’s life insurance coverage remains unchanged for 20 years. The policy John chooses should have a fixed monthly amount that he will pay each year (or month). Term life insurance offers lower initial premiums than other types of insurance (especially for younger people, so I would inquire as to what John’s age is). Term life is an economical way to buy a large amount of life insurance protection over a given, short (e.g. 20 years) period of time (Personal Financial Planning 11th Edition by Lawrence J. Gitman and Michael J. Joehnk page 250-251). Choosing this term policy will help keep John’s cash outlay as low as possible, and help protect his family financially until the children are grown, in the event of John’s demise.
—————————————————————————-
- The ABC Class A share mutual fund has a NAV (Net Asset Value) of $35.64 and an offer/purchase price of $37.81. Use this information to answer the following questions. You must show all work for full credit.
a. How many shares will you receive when you invest $10,000?
b. What is the percentage load?
c. What is the load charge, in dollars, for this transaction?
d. The fund in the above example is a front end load fund. If it were a no-load fund, what three criteria must be met for a mutual fund to be considered a no-load fund?
Answer:
a. 10000/35.64 = 280.58 shares purchased.
b. 35.64/37.81=.9426-1= 5.74% load
c. 37.81-35.64=2.17*280.58 shares = $608.86 load charge // or 10,000*5.74%= $574
d. If this fund were no-load, the criteria that must be met are: no 12(b)-1 fees, no loads, no fees, no transaction fees are charged, funds purchased at NAV without any front-end, back-end, or level sales charges.
—————————————————————————-
- You are trying to help a friend decide on what type of IRA to use for his retirement plan. How would you outline the differences between a traditional deductible IRA, a traditional non-deductible IRA, and a Roth IRA to him? (Please explain in detail and emphasize the tax issues of each)
Answer:
Traditional deductible IRA
This IRA can be opened by anyone without a retirement plan at their place of employment, regardless of income level, or by couples filing jointly (with adjusted gross incomes of less than $70,000 (or single tax filers with AGI’s of less than $50,000. Qualified individuals can make tax-deductible contributions of up to $5,000 a year (an equal tax-deductible amount can be contributed by a non-working spouse). This amount will likely change in the future, and is higher for individuals 50 years of age and older. All account earnings grow tax free until withdrawal, after which ordinary tax rates apply (note: 10% penalty applies to withdrawals made before age 59 1/2).
Traditional non-deductible (after-tax) IRA
This type of IRA is more open to anyone, regardless of income level or if they already have a retirement plan at their workplace. You can contribute $5,000 per year with after-tax dollars (contributions are not tax-deductible). Earnings to this account do accrue on a tax free basis are are not subject to tax until withdrawn, after the person reaches age 59 1/2 (same 10% penalty applies to withdrawals made before this age).
Roth IRA
This is a newer investment vehicle that can be opened by couples filing jointly with adjusted gross incomes of up to $150,000, regardless of whether they have retirement of pension plans. Roth’s are special because both the contributions (which are nondeductible, after-tax dollars) and withdrawals from the account are tax free. Up to $5,000 per year can be contributed to a Roth IRA, and all earnings in the account grow tax free. In order to withdraw from a Roth IRA account tax-free and without penalty, the account must have been open for at least 5 years and the individual is past the age of 59 1/2. As long as these conditions are met, you can make withdrawals from a Roth IRA tax-free.
—————————————————————————-
- The following questions pertain to the four basic estate planning documents.
What is a will? What is a living will? What is a healthcare power of attorney? What is a financial power of attorney, and why is important that individuals have these four documents?
Answer:
What is a will?
A will is a written and legally enforceable document expressing how a person’s property should be distributed on their death.
What is a living will?
A document that precisely states the treatments a person wants if they become terminally ill.
What is a healthcare power of attorney?
A written power of attorney authorizing an individual to make healthcare decisions on behalf of the principal when the principal is unable to make such decisions.
What is a financial power of attorney
Legal documents that authorizes another person to take over one’s financial affairs and act on his or her behalf.
Why is important that individuals have these four documents?
Is is important that individuals have these four documents, because without them they risk being incapacitated and not being able to make any choices for themselves. Also, a living will is not legally enforceable without a healthcare power of attorney, so these two documents must be combined. The healthcare power of attorney holds more power than a living will, but it is still good to have both to make sure your wishes are carried out. A living will is important without it, your estate (money and property) will be distributed based on state laws, and potentially given to people you would not choose (in percentages that you would have changed). For example, in Illinois if you die without a will, 50% of your estate goes to your spouse, and the other 50% to your children. A will could have changed the members your estate was given to, and the percentages distributed. The financial power of attorney is very powerful, and gives someone the ability to legally act on your behalf. This is one of the most important, if not the most important, estate planning document to have.
—————————————————————————-
- Bill and Sharon Smith would like to retire in 25 years. Bill works as a retail manager and has a salary of $50,000 per year. Sharon works in the local school district and earns $55,000. They currently spend $65,000 per year on household expenditures and expect to spend the same amount in retirement. Bill and Sharon expect Social Security to provide them with $22,000 in retirement benefits combined in today’s dollars. The Smith’s expect to earn 10% on their assets during their accumulation period and expect to earn 6% on their assets during retirement. Bill has a 401(k) at work in which he contributes 9% of his salary and his employer contributes 50 cents of the first 4% of employee salary. Sharon contributes 7% of her pay to a 403(b) plan. Bill’s 401(k) has a balance of $27,000 and Sharon’s 403(b) has a balance of $18,000. Assume a 3% inflation rate and that all payments are made at the end of the year.
Will the Smith’s be able to retire in 25 years and be able to achieve their expected lifestyle?
Answer:
66950 (includes 3% inflation)/.06 = Needs $1,115,833 at retirement in order to achieve $65,000 per year lifestyle that they currently enjoy.
Adding up what Bill and Sharon will be expecting in 25 years from their retirement plans, they will expect about $1,407,105 between the two of them, plus $22,000 from social security. I would tell them to keep investing as they are, because the market might not return their expected 10% APY over 25 years. It is better to be safe than sorry, and this couple seems to be doing very well, and working to exceed their retirement goal.
Bill:
a. TVM Calc:
N= 25
I= 10
PV= -27000
PMT= -5500 (see below calc)
FV= $833,445
Answer: $833,445 expected retirement value
401k: 50,000*.09 = 4500 + employer cont: (50000*.04*.5) = 1000 = 5500 total
Sharon:
a. TVM Calc:
N= 25
I= 10
PV= -18000
PMT= -3850
FV= $573,660
Answer: $573,660 expected retirement value
401k: 55000*.07 = 3850
Real Answers
| 1. | Question: | (TCO A) Use future or present value techniques to solve the following problems:
(Note: You can use tables or a financial calculator. If you use a calculator, please provide the inputs you used to solve the problems) (5 pts each = total 20 pts). a. Starting with $20,000, how much will you have in 20 years if you can earn five percent on your money? |
| My Answer: | a. TVM Calc: N= 20 I= 5 PV= -20000 PMT= 0 FV= $53,065.95 Answer: $53,065.95 b. TVM Calc: N= 15 I= 8 PV= -100000 PMT= 0 FV= $317,216.91 Answer: $317,216.91 c. TVM Calc: N= 10 I= 4 PV= -200000 PMT= 0 FV= $296,048.86 Answer: $296,048.86 d. TVM Calc: N= 40 I= 9 PV= 0 PMT= -$8,878.83 FV= 3000000 Answer: I would need to save $8,878.83 each year. | |
| Explanation: | a. PV = $20,000, N = 20, I = 5%, Solve for FV = $53,066 b. PV = $100,000, I = 8%, N = 15, Solve for FV = $317,217 c. PV = $200,000, N= 10, I= 4%, solve for FV = $296,049 d. I = 9%, N = 40, FV = $3 million, Solve for PMT = $8,879 |
|
| 2. | Question: | (TCO A) Construct a balance sheet for the Jones family from the following information. Be sure the format is correct. (20 pts for Balance Sheet) Is the Jones family solvent or insolvent? Yes, No? Explain.
Cash on hand 500 |
| My Answer: | ASSETS: Liquid Assets: Cash on hand $500 Total Liquid Assets $500 Investments: Stocks $10,000 Total Investments $10,000 Real Property: Primary residence (FMV) $225,000 Total Real Property $225,000 Personal Property: 2010 Acura $20,000 Stamp collection 1,500 Jewelry 1,000 Total Personal Property $22,500 Total Assets $258,000 —————————————- LIABILITIES AND NET WORTH: Current Liabilities: Bank credit card balance $5,000 Total Current Liabilities $5,000 Long-Term Liabilities: Mortgage $150,000 Auto loan balance 20,000 Total Long-Term Liabilities $170,000 Total Liabilities $175,000 —————————————- Net Worth $83,000 (258,000-175,000) Total Liabilities and Net Worth $258,000 The Jones family is solvent, as their net worth is $83,000, which is more than zero. This shows a presence of financial planning, and that the family has planned their finances well. They have a paid for car, and owe less on their mortgage than the house is worth, which is a good sign. | |
| Explanation: | Assets: Liabilities: Cash on hand 500 Primary residence 225,000 2010 Acura 20,000 Bank credit cards 5,000 Jewelry 1,000 Auto loan 20,000 Stocks 10,000 Mortgage 150,000 Stamp Collection 1,500 Total Assets $258,000 Total Liabilities $175,000 Net Worth $83,000
|
|
| 3. | Question: | (TCO B) Part 1 – The Smith family would like to itemize their deductions for the current tax year. Their Adjusted Gross Income (AGI) is $85,000. Their filing status is Married Filing Jointly. Looking at the items below, which ones can they itemize and what is the total they can take on their Schedule A Itemized Deductions? Show all of your work to obtain full credit.
Part 2 – Assuming that the Smith’s Standard Deduction would be $11,400 for this tax year and that they are in the 25 percent marginal federal income tax bracket, how much does itemizing save their family in taxes? Medical Expenses 5,000 |
| My Answer: | Part 1: Adjusted Gross Income (AGI) $85,000 Medical Expenses 5,000 (85000*.075=6375); the Smith family can not deduct any medical expenses since the total amount does not exceed 7.5% of their AGI. State Income Taxes Paid 5,000 – line #5, state income taxes are deductible . Real Estate Taxes 4,000 – line #6, personal property tax is deductible. Home Mortgage Interest Paid 10,000 – line #10 home mortgage interest reported on form 1098 is deductible Gifts to Charity 2,000 – line #16, Since they earn under the restricted AGI, they qualify for 50% deduction on these gifts to charity, as long as they have all their receipts and can prove the money was given; so $1,000 is deductible. Credit Card Interest 1,000 – this is not deductible. Unreimbursed Employee Expenses 2,000 – line #21 – you can deduct in excess of 2% of AGI; 85000*.02=1700; 2000-1700. they can deduct $300 Total they can take on their Schedule A Itemized Deductions: $5000+4000+10000+1000+300=$20,300 Part 2: Assuming a standard $11,400 deduction, they would save $8900 more (20300-11400) by using itemized deductions. Since they are in the 25% bracket, this would save the family .25*8900 = $2,225. | |
| Explanation: | Part 1Medical Expenses $0 (not allowed) ($5,000 – (.075 x $85,000) = -1,375 State Income Taxes Paid 5,000 Part 2 Savings for Standard Deduction = $11,400 x .25 = $2,850 |
|
| Comments: | Gifts to charity are fully deductible. | |
| 4. | Question: | (TCO C) Alan and Barbara are in the process of purchasing their first home. However, they cannot decide whether a 15-year fixed rate mortgage or a 30-year fixed rate mortgage is best for them. They have decided to finance $200,000 and can get the 15-year mortgage at 4.5 percent and the 30-year mortgage at 5 percent.
First of all, calculate the monthly payment of each loan. Next, discuss the pros and cons of a 15-year mortgage versus a 30-year mortgage. |
| My Answer: | 15-year mortgage: TVM Calc: N= 15 I= 4.5 PV= -200000 PMT= 18,622.76 FV= 0 Answer: 18622.76/12 = $1551.90/mo payment. 30-year mortgage: TVM Calc: N= 30 I= 5 PV= -200000 PMT= 13,010.29 FV= 0 Answer: 13,010.29/12= $1084.19/mo payment. If you can afford it, the clear winner is the 15 year mortgage, simply because you will pay far less interest over the course of the loan, and have the loan paid off twice as quickly. For example, the total money paid for the 15 year mortgage is $279,342, or $79,342 of interest (1551.90*180 mo), and the total money paid for the 30 year mortgage is $390,308.40, or $190,308.40 (1084.19*360 mo). They will save $110,966.40 over the course of the loan by going the 15-year mortgage route. This money can be used to help the family retire. However, the family needs to go over their monthly expenses to see if they can swing the additional $467/month. The family will need to discuss whether their short term goals (having a little extra money every month) is worth sacrificing $110,966 over 30 years. However, if the couple goes the 30-year route, and invests the additional $467/month for 15 years, assuming 8% interest earned, the couple would have a total future value: $163.318. However, an 8% APY is not guaranteed, while the $110,966 savings by choosing the 15-year over the 30-year mortgage is certain. | |
| Explanation: | 15-year loan: PV = $200,000, I = 4.5%, N = 12 x 15 = 180, Solve for PMT = $1,529.9930-year loan: PV = $200,000, I = 5%, N = 12 x 30 = 360, Solve for PMT = $1,073.64
The 30-year term offers you budget flexibility and the opportunity to qualify for a larger mortgage. You can also spread your mortgage payments over an extended period, offering the advantage of reduced monthly payments. In the example above, on a $200,000 mortgage, your payments would amount to roughly $450 per month less than the payment for a 15-year term. You still have the option to prepay your mortgage each month and reduce the term of a 30-year mortgage (assuming you do not have a prepayment penalty clause). However, if you incur an unexpected bill or simply have less cash flow in a given month, a 30-year term allows you the flexibility not to prepay your mortgage. The tradeoff to having financial flexibility with the 30-year term is that you will pay a slightly higher interest rate and accumulate equity at a slower rate. The primary attraction of a 15-year term is that it allows you to pay off your mortgage within 15 years. To many homeowners, a shorter term may offer an overwhelming advantage savings in time and total interest paid, not to mention piece of mind. Another plus of the 15-year term is the interest rate can be ¼% to ½% lower than the prevailing 30-year term. However, a 15-year term does have its disadvantages. The 15-year’s higher monthly payments can reduce your purchasing power. Looking again at the above example, the $450 per month (saved) in a 30-year term is roughly equivalent to $84,000 in buying power.
|
|
| Comments: | Need to calculate the monthly mortgage amount. Set periods per year at 12 instead of 1. | |
| 5. | Question: | (TCO D) John Jones is married with son, and would like to purchase enough life insurance to provide the following for his family:
Pay off home mortgage $200,000 If he were to die, his son and wife would receive $14,400 annually for 12 years from Social Security. His wife is also the primary beneficiary of his $100,000 group life policy. Given this information, how much more life insurance does John need? Additionally, John would like to keep his cash outlay as low as possible and the insurance policy that he purchases to last only 20 years. What type of insurance policy would you recommend? |
| My Answer: | Total money needed: 200000+20000+10000+60000+(60000*20=1,200,000) = $1,490,000 total benefit needed. However, he can already expect 14,400*12 = $172,800 from social security, and $100,000 from his group life policy, which equals a total of $272,800. Subtract $272,800 expected benefit minus the $1,490,000 total benefit needed, and John will need an additional $1,217,200 of additional life insurance. Since John wants to spend as little as possible on the policy and have it last only 20 years, he should choose a 20-year term life insurance policy. This way, the amount of John’s life insurance coverage remains unchanged for 20 years. The policy John chooses should have a fixed monthly amount that he will pay each year (or month). Term life insurance offers lower initial premiums than other types of insurance (especially for younger people, so I would inquire as to what John’s age is). Term life is an economical way to buy a large amount of life insurance protection over a given, short (e.g. 20 years) period of time (textbook page 250-251). Choosing this term policy will help keep John’s cash outlay as low as possible, and help protect his family financially until the children are grown, in the event of John’s demise. | |
| Explanation: | Pay off home mortgage $200,000 Pay off car loan 20,000 Final burial expenses 10,000 College education for his son 60,000 Annual living expenses for his family (60,000/yr. x 20 yrs.) 1,200,000 Gross Life Insurance Need 1,490,000Less Available Resources: Social Security Group life insurance policy (100,000) 20 year level premium term insurance recommended. |
|
| 6. | Question: | (TCO E) The ABC Class A share mutual fund has a NAV (Net Asset Value) of $35.64 and an offer/purchase price of $37.81. Use this information to answer the following questions. You must show all work for full credit.
a. How many shares will you receive when you invest $10,000? b. What is the percentage load? |
| My Answer: | a. 10000/35.64 = 280.58 shares purchased. b. 35.64/37.81=.9426-1= 5.74% load c. 37.81-35.64=2.17*280.58 shares = $608.86 load charge // or 10,000*5.74%= $574 d. If this fund were no-load, the criteria that must be met are: no 12(b)-1 fees, no loads, no fees, no transaction fees are charged, funds purchased at NAV without any front-end, back-end, or level sales charges. | |
| Explanation: | a. $10,000/$37.81 = 264.480 shares b. $37.81 – $35.64/$37.81 = 5.75% c. .0575 x $10,000 = $575 d. 12b-1 fee less than or equal to .25% annually, no front end load, no back end load or contingent deferred sales charge (CDSC). |
|
| 7. | Question: | (TCO F) You are trying to help a friend decide on what type of IRA to use for his retirement plan. How would you outline the differences between a traditional deductible IRA, a traditional non-deductible IRA, and a Roth IRA to him? (Please explain in detail and emphasize the tax issues of each) |
| My Answer: | Traditional deductible IRA This IRA can be opened by anyone without a retirement plan at their place of employment, regardless of income level, or by couples filing jointly (with adjusted gross incomes of less than $70,000 (or single tax filers with AGI’s of less than $50,000. Qualified individuals can make tax-deductible contributions of up to $5,000 a year (an equal tax-deductible amount can be contributed by a non-working spouse). This amount will likely change in the future, and is higher for individuals 50 years of age and older. All account earnings grow tax free until withdrawal, after which ordinary tax rates apply (note: 10% penalty applies to withdrawals made before age 59 1/2). Traditional non-deductible (after-tax) IRA This type of IRA is more open to anyone, regardless of income level or if they already have a retirement plan at their workplace. You can contribute $5,000 per year with after-tax dollars (contributions are not tax-deductible). Earnings to this account do accrue on a tax free basis are are not subject to tax until withdrawn, after the person reaches age 59 1/2 (same 10% penalty applies to withdrawals made before this age). Roth IRA This is a newer investment vehicle that can be opened by couples filing jointly with adjusted gross incomes of up to $150,000, regardless of whether they have retirement of pension plans. Roth’s are special because both the contributions (which are nondeductible, after-tax dollars) and withdrawals from the account are tax free. Up to $5,000 per year can be contributed to a Roth IRA, and all earnings in the account grow tax free. In order to withdraw from a Roth IRA account tax-free and without penalty, the account must have been open for at least 5 years and the individual is past the age of 59 1/2. As long as these conditions are met, you can make withdrawals from a Roth IRA tax-free. (textbook page 473-474) | |
| Explanation: | Deductible IRAs allow investors to contribute up to $5000 per year in 2010 and up to $6000 for those ages 50 and older. Contributions are restricted to those under a certain income level and without access to an employer retirement plan. The investor gets a current tax deduction as taxes are deferred until withdrawal at retirement.In differentiating between a nondeductible IRA and a Roth IRA, a nondeductible IRA is open to anyone regardless of their income level or whether they are covered by a retirement plan at their place of employment. Contributions of up to $5,000 a year in 2010 and $6000 for those age 50 and older, can be made to this account, but they are made with after-tax dollars. However, the earnings do accrue tax free are not subject to tax until they are withdrawn after the individual reaches age 59 ½.
A Roth IRA is established for the purpose of providing funds for one’s retirement, contributions can only be made if one has earned income (except for the non-working spouse), and the maximum allowable contribution is $5000 a person in 2010 and $6000 for those ages 50 and older, contributions are nondeductible/after-tax dollars, all earnings in the account grow tax free and all withdrawals from the account are also tax free, as long as the account has been open for a least five years and the individual is past the age of 59 1/2 . In other words, as long as these conditions are met, you won’t have to pay taxes on any withdrawals you make from your Roth IRA. Both traditional and deductible and non-deductible IRAs require that the investor make Required Minimum Distributions (RMDs) at age 70-1/2 and pay taxes while Roth have no such requirement. |
|
| 8. | Question: | (TCO G) The following questions pertain to the four basic estate planning documents. What is a will? What is a living will? What is a healthcare power of attorney? What is a financial power of attorney, and why is important that individuals have these four documents? |
| My Answer: | What is a will? A will is a written and legally enforceable document expressing how a person’s property should be distributed on their death. What is a living will? A document that precisely states the treatments a person wants if they become terminally ill. What is a healthcare power of attorney? A written power of attorney authorizing an individual to make healthcare decisions on behalf of the principal when the principal is unable to make such decisions. What is a financial power of attorney Legal documents that authorizes another person to take over one’s financial affairs and act on his or her behalf. Why is important that individuals have these four documents? Is is important that individuals have these four documents, because without them they risk being incapacitated and not being able to make any choices for themselves. Also, a living will is not legally enforceable without a healthcare power of attorney, so these two documents must be combined. The healthcare power of attorney holds more power than a living will, but it is still good to have both to make sure your wishes are carried out. A living will is important without it, your estate (money and property) will be distributed based on state laws, and potentially given to people you would not choose (in percentages that you would have changed). For example, in Illinois if you die without a will, 50% of your estate goes to your spouse, and the other 50% to your children. A will could have changed the members your estate was given to, and the percentages distributed. The financial power of attorney is very powerful, and gives someone the ability to legally act on your behalf. This is one of the most important, if not the most important, estate planning document to have. | |
| Explanation: | A will sets forth how and to whom your property will pass upon your death. It is important to remember, however, that a will only transfers property which you own in your name alone (or in which you have a divisible interest). Property owned as a joint tenant with right of survivorship, or for which a beneficiary has been designated (such as proceeds of a life insurance policy), will not be transferred by a will. A will generally names a personal representative of your estate (executor or executrix), may include bequests of specific sums or property to named individuals and/or charities, should name a guardian of any minor children, and generally disposes of all of your property. A will is only effective upon death and can be changed as your goals and wishes change.A living will sets forth your wishes regarding medical intervention if you are terminally ill or if you are in a persistent vegetative state. Many people think of a living will as a declaration that, if they are terminally ill or in a persistent vegetative state, they wish to die naturally without undue medical intervention designed to prolong their life.
A healthcare power of attorney, you authorize a person or persons to make health care decisions for you if you are unable to do so. A healthcare power of attorney can include specific directions for your health care representative to follow, including but not limited to, a living will-type provision. A healthcare power of attorney does not supersede your ability to make your own health care decisions. Rather, the person named as your health care representative has the authority to act only if you are unable to do so as determined by your physicians. A financial power of attorney, you authorize a person to take care of your financial transactions. It can be conditioned upon your inability to take care of your financial transactions yourself but more often is not so limited. |
|
| 9. | Question: | Bill and Sharon Smith would like to retire in 25 years. Bill works as a retail manager and has a salary of $50,000 per year. Sharon works in the local school district and earns $55,000. They currently spend $65,000 per year on household expenditures and expect to spend the same amount in retirement. Bill and Sharon expect Social Security to provide them with $22,000 in retirement benefits combined in today’s dollars. The Smith’s expect to earn 10% on their assets during their accumulation period and expect to earn 6% on their assets during retirement. Bill has a 401(k) at work in which he contributes 9% of his salary and his employer contributes 50 cents of the first 4% of employee salary. Sharon contributes 7% of her pay to a 403(b) plan. Bill’s 401(k) has a balance of $27,000 and Sharon’s 403(b) has a balance of $18,000. Assume a 3% inflation rate and that all payments are made at the end of the year.
Will the Smith’s be able to retire in 25 years and be able to achieve their expected lifestyle? |
| My Answer: | 66950 (includes 3% inflation)/.06 = Needs $1,115,833 at retirement in order to achieve $65,000 per year lifestyle that they currently enjoy. Adding up what Bill and Sharon will be expecting in 25 years from their retirement plans, they will expect about $1,407,105 between the two of them, plus $22,000 from social security. I would tell them to keep investing as they are, because the market might not return their expected 10% APY over 25 years. It is better to be safe than sorry, and this couple seems to be doing very well, and working to exceed their retirement goal. Bill: a. TVM Calc: N= 25 I= 10 PV= -27000 PMT= -5500 (see below calc) FV= $833,445 Answer: $833,445 expected retirement value 401k: 50,000*.09 = 4500 + employer cont: (50000*.04*.5) = 1000 = 5500 total Sharon: a. TVM Calc: N= 25 I= 10 PV= -18000 PMT= -3850 FV= $573,660 Answer: $573,660 expected retirement value 401k: 55000*.07 = 3850 | |
| Explanation: | Approx. number of years. to retirement 25 Current level of annual expenditures $65,000 Estimated household expenditures in ret. as % of current 100% Estimated annual expenditures in retirement $65,000 Social Security $22,000 Future value of additional income needed $90,032 Expected return on assets held after retirement 6% PV 45000 |
|
| 10. | Question: | Using the information in the previous problem: Bill and Sharon have come to you 5 years later and ask for your assistance. Bill just received an increase in salary to $60,000 and Sharon’s salary has increased to $64,000 starting this year. Assume all other facts are unchanged and the Smith’s have been able to achieve their pre-retirement rate of return. Will the Smith’s be able to reach their retirement goal? |
| My Answer: | Yes, they were on track before, and now they will be exceeding their goals with the increased income. They should stay on track as stated before, they do not know what future percentage yield the market will earn for them. As they approach closer to retirement, the 10% expected return may dwindle, as they change their holdings to become less aggressive, and more stable. | |
| Explanation: | Approx. number of years. to retirement 20Future value of additional income needed $90,032
Expected return on assets held after retirement 6% PV 129556 |
|
| 11. | Question: | Steve and Sandra Johnson are married and have two children ages 10 and 6. Steve works as a sales manager and Sandra is an office manager for a doctor’s office. Steve earned $40,000 in salary and $24,000 in commissions in 2010. Sandra’s salary was $44,000. In addition, the Johnson’s received $300 in interest from their primary checking account and $1,550 in dividends on a money market account. Further, they received a $15,000 inheritance from Sandra’s great aunt. The Johnson’s sold two stocks during 2010. Stock A was sold for $10,000 and had been purchased two years earlier for $8,000. Stock B was sold for $4,000 and had been purchased three years earlier for $10,000. They had $5,000 of unreimbursed medical expenses. Steve and Sandra contributed $150 per month to their church. Steve incurred $1,000 of unreimbursed travel costs throughout the year. Real Estate Taxes on their primary residence totaled $3,500. Interest paid on their home mortgage was $6,500. Steve and Sandra each contributed $5,000 to a Roth IRA. The standard deduction for 2010 is $11,400 and the personal exemption amount is $3,650. Assume tax status is married filing jointly.
What is the Johnson’s average tax rate for 2010? |
| My Answer: | exeptions: 2 (2 children). income: 40,000+24,000 = 64,000. + 44,000 sandra = 108,000. + 2,000 at 15% rate. Ave tax rate is 25%, since their income is under $137,300 and are married filing jointly. | |
| Explanation: | Wages and Salaries $108,000 Interest $300 Dividends $1,550 Capital loss ($3,000) Total Income $106,850 AGI $106,850 Less Itemized deductions: Charitable contribution $1,800 Less personal exemptions: 4 exemptions at $3,650 each ($14,600) Taxable Income $80,450 Using tax table taxes due $12,488 Tax due $10,488 Average tax rate 13.04% |
|
| 12. | Question: | Larry has the option of either a $3,000 rebate or 0% financing for 5 years from the local car dealer. Larry has negotiated a price of $30,000 for the car before any rebates. Larry can obtain financing at 4.9% for 48 months. What is the total cost of taking the 0% financing? What is the total cost of taking the rebate and financing at 4.9% for 48 months? Which option should Larry take? Explain. Assume monthly payments. |
| My Answer: | a. TVM Calc: N= 5 I= 4.9 PV= 30000 PMT= 564/mo for 60 months. FV= 0 | |
| Explanation: | Zero Percent FinancingMonthly payment is $30,000/60 months = $500
Total cost is $30,000.
Rebate $30,000-$3,000 = $27,000 price of car. PV 27,000 $620.57*48 months = $29,787.36 |
|
Speak Your Mind