CH21 Flashcards
What is the current U.S. tax rate for interest income?
Same rate as ordinary income
Interest income is taxed at the same rate as regular income according to current U.S. law.
What are the tax rates for dividends and long-term capital gains for low- to moderate-income investors?
0%
This rate applies to qualifying low- to moderate-income investors.
What is the tax rate for dividends and long-term capital gains for middle- to upper-income investors?
15%
This rate applies to qualifying middle- to upper-income investors.
What is the tax rate for dividends and long-term capital gains for highest-income households?
20%
This rate applies to the highest-income households.
What is the maximum contribution limit for a 401(k) plan in 2023?
$22,500
Employees may contribute this amount to their 401(k) plans in 2023.
What is the additional contribution limit for individuals over age 50 in a 401(k) plan?
$30,000
Individuals over age 50 can contribute an additional amount to their 401(k) plans.
What is the annual contribution limit for IRAs?
$6,500
This limit applies to standard IRA contributions.
What is the additional contribution for individuals over age 50 to IRAs?
$1,000
This is the additional amount allowed for those over age 50.
What penalty is incurred for early withdrawal from an IRA before age 59.5?
10%
This penalty applies to withdrawals made before the age of 59.5.
What is the tax treatment of contributions to a Roth IRA?
Not tax-sheltered, but investment earnings are not taxed
Contributions to Roth IRAs are made with after-tax dollars.
What is the tax treatment of contributions to a Traditional IRA?
Tax-sheltered until retirement
Contributions to Traditional IRAs are tax-deductible.
What are deferred annuities?
Tax-sheltered accounts offered by life insurance companies
Earnings in deferred annuities are tax-free until payout.
What factors are considered in developing a retirement plan?
- Time until retirement
- Life expectancy
- Rate of return
- Allocation of income to savings
These factors influence the effectiveness of a retirement plan.
How does inflation affect purchasing power?
Inflation erodes purchasing power
Real consumption equals nominal consumption divided by price deflator.
What formula is used to calculate real return accounting for inflation?
ROR = (ROR - i) / (1 + i)
Where ROR is nominal return and i is inflation.
What is the real rate of return if inflation is 3% and nominal ROR is 6%?
2.91%
Calculated as (.06 - .03) / (1 + .03).
What is the price deflator size at age 35 with 3% inflation?
1.16
Calculated as (1 + i)^n with n being 5 years.
What is the price deflator size at age 65 with 3% inflation?
2.81
Calculated as (1 + i)^n with n being 35 years.
What must investors do to overcome inflation?
- Increase savings
- Achieve higher ROR on investments
Higher returns or savings mitigate inflation’s impact.
What is the impact of taxes on retirement benefits?
Taxes reduce retirement benefits available
Overcoming taxes requires larger allocations to savings.
What is a flat tax?
Taxes all income above exemption at a fixed rate
Flat taxes can impact retirement savings.
What is the purpose of Social Security?
Provide minimum retirement benefits to all workers
Social Security is a federal pension plan.
What percentage of income is paid to Social Security?
6.2%
Workers also pay 1.45% toward Medicare.
What is the benefit determination period for Social Security?
Top 35 years of earnings and contributions
Only the highest earning years count towards benefits.
What happens to Social Security benefits if you retire early (at age 62)?
Reduced amount
Benefits are lower if retirement occurs before the full retirement age.
What is the largest long-term consumption item?
Dwelling
Home ownership represents a significant financial commitment.
What is the main risk associated with home ownership?
Largest consumption risk
Houses are illiquid investments with transaction costs.
What is a safeguard for tough times?
Not trying to buy too much house
This implies being cautious about financial commitments during uncertain times.
What type of investments are houses considered?
Illiquid investments
Illiquid investments are those that cannot be quickly sold or exchanged for cash without a substantial loss in value.
What are the transaction costs associated with?
Buying and selling
Transaction costs can significantly impact the overall financial outcome of real estate investments.
Does the value of a house always increase?
No
Value does not always increase, which can lead to financial loss.
What is the largest long-term consumption item?
Dwelling
A dwelling represents a significant portion of long-term expenses for individuals and families.
What is responsible for the largest consumption risk?
Dwelling
The financial burden of housing can pose substantial risks to personal finance.
What is a life annuity?
An annuity that lasts for your entire life
This financial product provides regular payments until the death of the annuitant.
Who bears the risk in a life annuity at the time of death?
Provider
The provider of the annuity takes on the risk of continuing payments until the annuitant passes away.
What is adverse selection?
Tendency for proposed deal to attract the type of party who would make the deal a losing proposition to the offering party
This concept is crucial in insurance and finance where risk is unevenly distributed.
What is moral hazard?
One party to a contract has an incentive to change behavior to make the contact less attractive to the other party
Moral hazard can occur when one party is shielded from risk, leading to risky behavior.
