Equations Flashcards

Equations

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1
Q

Equivalent Tax Credit for Itemized Deduction

Assume a taxpayer is in the 35% marginal income tax bracket and has enough deductions to itemize. Calculate the equivalent tax credit that would provide the same tax benefit as a $3,000 itemized deduction.

A

Marginal Tax Rate x Itemized Deduction = Equivalent Tax Credit

3,000 x .35 = 1,050

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2
Q

Inflation Adjusted Discount Rate

Bob is a fisherman with the local fish market. He and his wife Mary want to retire in 20 years. They expect to live approximately 25 years after retirement and need $40,000 (in today’s dollars) annually during retirement. Unfortunately, they have just spent their savings on refurbishing their boathouse and have only $12,000 in retirement savings. Inflation is currently 2% and is expected to continue indefinitely. Bob believes he can earn an 8% rate of return before retirement but expects to earn only 6% during retirement because of the change in his portfolio’s asset allocation at retirement. How much does Bob need to save at the end of each year to meet his retirement needs?

A

{[(1 + Nominal) ÷ (1 + Inflation Rate)] - 1} x 100

Step 1: Inflate needs to find FIRST Year of Retirement Payment by Solving for Future Value
BEG Mode
PV	= −40,000 
n	= 20 
i	= 2 
FV	= 59,437.90 

Step 2: Find the Sum that you need to fund Annual Payment found before while taking into account that Sum will increase by a real rate of return
BEG mode
PMT = 59,437.90
n = 25
i= [(1.06 ÷ 1.02) − 1} × 100 (inflation-adjusted discount rate)
PVAD = 973,006.62

Step 3: Determine the annual funding requirement. Don't use real interest rate because the inflation rate has already been taken into account:
FV	= $973,006.62 
PV	= −12,000 
n	= 20 
i	= 8 
PMT	= 20,040.11, or $20,040.11
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