Module 8 Employer Retirement Plan Selection Flashcards
If a businessowner client is of an older age, near his retirement date, and just establishing a qualified plan, which of these plans would generally NOT be most advantageous to the owner?
A)
Traditional profit-sharing plan
B)
An age-weighted profit-sharing plan
C)
Traditional defined benefit plan
D)
New comparability plan
A
A traditional profit-sharing plan would not allow the plan contributions to be skewed for the benefit of the older owner. All of the other plan choices listed would allow greater contributions for the older owner.
LO 8.1.2
Use the following information about Kevin and Cindy, a married couple, to answer the question that follows.
Kevin and Cindy are both 38 and are planning to retire at 65.
They estimate that they will need a lump sum of $2.4 million at retirement to provide the income stream required during their retirement years.
They project that their current assets will grow to a value of $1.9 million at the first year of retirement.
They feel they can earn a 6% after-tax return on their investments and would like to assume that inflation will average 4% over the long term.
They would like to increase their annual savings amount each year as their incomes increase.
They would like to assume a 30-year period of retirement.
They have no heirs and would like to assume the worst-case scenario: that they will use up all their assets during retirement.
They would like you, their financial planner, to determine the annual serial saving requirement needed to make up for their asset shortfall.
What is the first end-of-year savings payment, adjusted for inflation that Kevin and Cindy must set aside?
A)
$8,626
B)
$7,849
C)
$5,157
D)
$4,960
c
First, the capital utilization method was used to calculate their shortfall of $500,000 ($2,400,000 – $1,900,000). This shortfall must be deflated at a 4% rate over the 27 years until retirement (age 38 to age 65). The deflated value of additional savings needed at retirement is $173,408.
Next, determine the amount that they need to save at the end of the first (current) year. This amount will then be increased at the inflation rate each year during the preretirement period. The variables are: FV $173,408 (the deflated value of additional savings needed at retirement), 27 years until retirement, 1.9231% inflation-adjusted yield using 6% after-tax return, and a 4% inflation rate. The result of $4,960 must then be adjusted for inflation since the savings deposit is assumed to be made at the end of the year. Thus, $5,157 is the first year’s serial savings need.
The other choices are incorrect for the following reasons:
$4,960 is the result when one assumes the payments are made at the beginning of the year, i.e., $4,960 × 1.0
$7,849 is the level payment amount using $500,000, 27 years, and 6%
$8,626 is the result when it is assumed that $173,408 is a present value
LO 8.3.2
Joe and Tammy, both age 45 with a combined AGI of $200,000, have become good clients of Frank, a CFP® professional, since coming to Frank several years ago for help in developing a plan to retire at age 55. As part of the plan, an ongoing investment plan was established, and Joe and Tammy have been dedicated to saving the amount called for in the plan to reach their goal. Lately, Frank has noticed Joe’s and Tammy’s investment preference has become far more conservative than when the plan for early retirement was developed. What should Frank do next as it relates to the retirement plan?
A)
Frank should discourage Joe and Tammy from becoming more conservative because they are still relatively young.
B)
Frank should recommend tax-free municipal bonds because of Joe and Tammy’s combined AGI.
C)
Frank should discuss the change in investment preference with Joe and Tammy and revise the retirement calculations if Joe and Tammy’s risk tolerance has changed.
D)
Frank should recommend a portfolio of government bonds for added security.
c
Assuming a lower rate of return in the retirement plan calculations may impact the amount of ongoing investments necessary to reach Joe’s and Tammy’s previously stated retirement goal. Without first learning the reason behind the investment preference change, it would be premature to encourage Joe and Tammy to continue to assume more risk or for Frank to recommend government bonds or municipal bonds.
LO 8.2.1
Which of the following statements is CORRECT?
In a single-participant defined benefit plan, the employer-participant is assuming all of the investment risk.
An owner-employer may not wish to assume the investment risk for employees
A)
II only
B)
Both I and II
C)
I only
D)
Neither I nor II
both
The answer is both I and II. For a single employee defined benefit plan in which the only employee is also the owner (which would be the case the vast majority of the time), the owner and the employee/worker are the same person. However, the contribution would technically come from the employer, not the employee.
LO 8.1.1
Which of these retirement plans, maintained by an eligible employer, would also permit the employer to establish a SIMPLE IRA?
A)
Section 403(b) plan
B)
Section 457 plan
C)
Traditional Section 401(k) plan
D)
Money purchase plan
B
To establish a SIMPLE (IRA or Section 401(k)), an employer cannot generally maintain another retirement plan. However, a Section 457 plan is technically a nonqualified plan and, therefore, does not constitute a plan for purposes of establishing a SIMPLE of any type.
LO 8.1.1
Which of these should a businessowner accomplish before considering the adoption of a retirement plan?
Purchase personal and business liability insurance.
Establish cash reserves sufficient to cover potential emergencies.
Ensure the business has sufficient cash flow to support ongoing funding of the plan.
A)
I, II, and III
B)
II only
C)
III only
D)
I only
All
Definitely all, first one is very important, remember liability claims can be unlimited.
A businessowner (or a person planning for his own retirement) should accomplish all of these objectives before considering the adoption of a retirement plan. However, a starter 401(k) allows workers to save for their own retirement with minimal costs to the employer.
LO 8.1.1
Assume Bernard, age 55, is planning to retire in 10 years at age 65. He is a sole proprietor of a business with 15 employees but has not yet implemented a formal retirement plan for the business. Bernard’s company currently has a strong cash flow which is expected to continue. His own personal savings retirement need is $85,000 per year, and Bernard pays himself only $95,000. The company can afford to contribute $100,000 this year for Bernard’s account to any retirement plan that is implemented.
Furthermore, Bernard will commit to an annual contribution necessary to fund the retirement plan if needed. Considering only this limited information, which of the following types of qualified retirement plans would you recommend for Bernard and his business?
A)
Profit-sharing plan
B)
Stock bonus plan
C)
Money purchase plan
D)
Traditional defined benefit plan
D
Profit sharing doesn’t make much sense since you can only plop 22,500 into it. Maybe a solo 401k is more, not sure how those work. Stock bonus doesn’t make sense because sole proprietorships can’t issue stock. So it’s between MPPP and TDBPP. Defined benefit makes more sense since you have significantly higher contribution limits (I think none), and you have strong cash flows to support that.
A traditional defined benefit plan is most appropriate for Bernard and his business. The business has favorable cash flow and can commit to the annual contribution required by the defined benefit approach. In addition, Bernard’s savings need as a percentage of his compensation exceeds anything possible in a defined contribution plan. Finally, Bernard is currently age 55 with only 10 years until retirement.
LO 8.1.2
All of these are prohibited investment vehicles for IRAs except
A)
municipal bonds.
B)
antiques and artwork.
C)
life insurance.
D)
gold and silver coins from Canada.
A
Remember, gold and silver coins I BELIEVE are okay if they’re federally minted. Collectibles, no good.
Investing in tax-sheltered vehicles such as municipal bonds is allowable, but, it is generally not a good idea because the tax-sheltered income from a municipal bond is not necessary in an IRA. For exam purposes, municipal bonds should never be recommended for an IRA or retirement account.
LO 8.2.1
Ross owns a successful manufacturing business as a C corporation. Thanks to his firm’s culture of hard work, Ross is willing to share some ownership of the company with his workers. The business is growing at 18% per year, and it could grow faster if he had more cash to reinvest in the business. Ross would like to begin taking care of his retirement needs and also those of his of his workers, but he puts every penny he makes back into the company. What type of qualified plan should Ross select?
A)
Money purchase plan
B)
Profit-sharing plan
C)
Defined benefit plan
D)
Stock bonus plan
D
The key here is “willing to share some ownership”. That’s an immediate flag that stock will be in the answer.
Profit sharing is not ownership of the company.
The keys are that the company lacks cash to contribute to a retirement plan and the owner does not object to sharing some of the ownership of the company
LO 8.1.1
David has been calculating his retirement savings needs. He has $250,000 of assets set aside now. His goal is to have $800,000 in 15 years. How much more does he need to save, assuming a 7% annual after-tax rate of return throughout this period? (Round to the nearest dollar.)
A)
$550,000
B)
$110,242
C)
$689,758
D)
$289,957
B
Think backwards. $250,000 today, assuming a 7% return will be worth a lot more later. Too lazy to calc again. But just do 250k(1+.07)^15. Or just 250k1.07 and then hit equals exactly 15 times. That gives you how much money will be left in 15 years. Around $110k more will be needed at that time
Calculating the future value of David’s current retirement assets: −$250,000 (PV) 15 years from now (N) at a 7% return (I/YR) equals $689,758 (FV). This leaves a difference of $110,242 ($800,000 − $689,758) to be saved by David.
LO 8.3.2
All of these are primary assumptions that are made in any retirement needs analysis calculation except
A)
the type of retirement plan used by the client.
B)
the client’s age at retirement and anticipated life expectancy.
C)
the projected total rate of annual investment return.
D)
the anticipated annual rate of inflation.
a
The type of retirement plan used by a client is not an assumption in the retirement needs analysis. The other choices are primary assumptions made in any retirement needs analysis.
LO 8.3.1
Which of these retirement plans would be appropriate for a general partnership with stable cash flows?
A)
Age-weighted profit-sharing plan
B)
Employee stock ownership plan (ESOP)
C)
Stock bonus plan
D)
Section 403(b) plan (TSA)
A
Partnerships can’t issue stock. So ESOP and Stock bonus are out. 403bs are for non-profits, and this says nothing about that. Age-weighted is left.
An ESOP and stock bonus plan may only be established by an S or C corporation. A Section 403(b) plan (TSA) is only available to certain tax-exempt organizations. An age-weighted profit-sharing plan is the only plan appropriate for a general partnership from the choices given.
LO 8.1.1
Which of these statements is false regarding the various limits that apply to retirement plans?
A)
The maximum amount that is allowed to be contributed to a defined contribution plan in 2024, counting both employee and employer contributions, is $69,000 or 100% of compensation, whichever is greater.
B)
The maximum annual employee deferral amount for workers under age 50 for 401(k) plans, 403(b) plans, and Section 457 plans is $23,000 in 2024.
C)
The age 50 catch up available for 401(k) plans, 403(b) plans, Section 457 plans, and SARSEP plans is $7,500 in 2024.
D)
The maximum annual employee deferral amount for workers under age 50 for SIMPLE plans is $16,000 in 2024.
a
The Section 415 maximum contribution amount in 2024 is $69,000 or 100% of compensation, whichever is less.
LO 8.1.1
Tom and Martha, longtime clients of yours, have reviewed their retirement planning and believe they do not have time to accumulate sufficient retirement assets to retire in six years when Tom is 62. Which of the following alternatives should they consider?
Retire at an older age
Save more
Reduce the amount of income they require at retirement
A)
I, II, and III
B)
II only
C)
I and II
D)
I only
All
Because the desired retirement age is so soon, the amount of retirement assets available may be insufficient to allow for retirement at age 62. Therefore, all of the alternatives should be considered.
LO 8.3.1
Paul estimates he will need a $75,000 annual income in today’s dollars when he retires 10 years from now. He assumes a 3% annual rate of inflation, a 5% after-tax rate of return on his investments, and a 20-year retirement period. Using the level payment approach, how much will Paul need to save in a single annual payment at the end of each year to fund his retirement need?
A)
$134,331.53
B)
$120,880.49
C)
$100,794.00
D)
$75,000.00
A
Paul will need to make 10 level annual payments of $134,331.53 at the end of each year.
Step 1: What will it take to produce $75,000 of purchasing power in 10 years?
$75,000, PV
3, I/YR (I/Y for the TI BA II Plus)
10, N
FV Answer: $100,793.7285
Step 2: How much do they need at retirement to pay a serial payment of $100,793.7285 at the beginning of each year for 20 years?
$100,793.7285, PMT
20, N
[(1.05 ÷ 1.03) – 1] × 100, I/YR (This number is 1.9417) (I/Y for the TI BA II Plus)
0, FV
Shift Mar (To get into the Begin Mode) (For the TI BA II Plus, 2ND, BGN, 2nd, Enter, CE/C to get into the Begin Mode) PV Answer is $1,689.607.5595 (CPT, PV for the TI BA II Plus)
Step 3: How much needs to be saved as a level payment at the end of each year until retirement so the account will have $1,689,607.5595?
$1,689,607.5595, FV
10, N
5, I/YR (I/Y for the TI BA II Plus)
O, PV
Shift, MAR (To change to the End Mode) (For the TI BA II Plus, 2ND, BGN, 2nd, Enter, CE/C to get into the End Mode)
PMT Answer $134,331.53
LO 8.3.2
Which of these types of qualified retirement plans do NOT allow integration with Social Security?
Traditional defined benefit plan
Money purchase plan
Profit-sharing plan
Employee stock ownership plan (ESOP)
A)
II and IV
B)
IV only
C)
I, II, III, and IV
D)
II, III, and IV
IV only
How can you integrate social security with literal Stock.
An ESOP may not be integrated with Social Security.
LO 8.1.2
Which type of plan provides the most employee motivation?
A)
Money purchase plan
B)
Profit-sharing plan
C)
Defined benefit plan
D)
Traditional 401(k)
B
Company does better (profits) you get more potentially.
The plan contributions with a profit-sharing plan are loosely tied to the firm making a profit. Even though an employer is not required to make a profit to contribute to the profit-sharing plan, this is the only type of retirement plan listed that gives the workers ownership in the firm and thus more motivation to see things like an owner. “Motivation” is a CFP buzzword for a profit-sharing plan. This is the motivation to work harder, not the motivation to prepare for retirement.
LO 8.1.1
Which of these is a retirement plan that is easily understood by employees, the employee assumes the investment risk, does not favor older plan participants, and permits elective deferrals?
A)
Target benefit plan
B)
SIMPLE IRA
C)
SEP plan
D)
Cash balance plan
B
EE Risk - rules out DB plans A and D
Elective deferrals from EE - rules out C
SIMPLE IRA is left.
The question is describing a SIMPLE IRA. A SEP does not allow elective deferrals by the employees. All SEP contributions must come from the employer. The grandfathered SAR-SEP plans allowed for both employer and employee contributions. A target benefit plan favors older employees.
LO 8.1.2
Which of these qualified plans can an S corporation implement?
Profit-sharing plan
Stock bonus plan
Money purchase plan
Employee stock ownership plan (ESOP)
A)
I, II, III, and IV
B)
II, III, and IV
C)
I, II, and III
D)
I and II
all four
S corporations can establish stock bonus and ESOPs.
LO 8.1.1
Carol has an additional retirement need of $30,000 annually in today’s dollars. She will retire in 15 years and projects a retirement period of 20 years. Carol believes she can achieve a 6% after-tax rate of return and is assuming a 4% annual rate of inflation. She has accumulated $175,000 toward her retirement plan. What lump-sum amount should Carol have accumulated over the next 15 years to support her retirement income need?
A)
$873,553
B)
$907,144
C)
$503,707
D)
$732,144
B
Carol’s total retirement fund needed to support her desired standard of living is $907,144, calculated as follows:
Carol’s first year retirement income need is $54,028.
PV = –$30,000
I/YR = 4
N = 15
FV = $54,028
The total capital required to support this need for 20 years is $907,144.
In BEGIN mode (the client will make annual withdrawals at the beginning of each year)
PMT = $54,028
N = 20
I/YR = 1.9231 [(1.06 ÷ 1.04) – 1] × 100
PVAD = –$907,144
LO 8.3.2
All of these are primary assumptions in any retirement needs calculation except
A)
the projected rate of annual investment return.
B)
the number of dependents a client will have at retirement.
C)
the client’s age at retirement and anticipated life expectancy.
D)
the anticipated annual rate of inflation.
b
idk about this one chief
The answer is the number of dependents a client will have at retirement. Even though many grandparents are financially impacted by their adult children or their grandchildren, this is not a primary retirement assumption for all retirees. There are three primary assumptions that are made in any retirement needs analysis calculation. They are
the anticipated annual rate of inflation;
the projected rate of annual investment return; and
the client’s age at retirement and anticipated life expectancy.
LO 8.3.1
James and Hannah have determined that they will need a monthly income of $6,000 at the beginning of each month during retirement. They expect to receive Social Security retirement benefits amounting to $3,500 per month. Over the 12 remaining years of their preretirement period, they expect to generate an average annual after-tax investment return of 8%; during their 25-year retirement period, they want to assume a 6% annual after-tax investment return.
How much do they need to save at the end of each month to build the necessary retirement fund?
A)
$1,785
B)
$1,653
C)
$1,611
D)
$1,621
d
The monthly retirement income need is not specified as “today’s dollars,” and no inflation rate specified; therefore, it is assumed that the $2,500 net monthly income need represents retirement dollars, and the retirement period income stream is level.
First, to calculate the lump sum needed at the beginning of retirement, discount the stream of monthly income payments at the investment return rate:
Set calculator to the Begin mode and 12 periods per year, then input the following:
2500 = PMT This number is positive because it will be coming into the clients’ checking account each month.
300 = 25, Shift, N (the calculator should read 300.0000 [25 × 12]) (For the TI BA II Plus with 12 compounding periods per year already set, 25, 2ND, xP/Y, N)
6 = I/YR (I/Y for the TI BA II Plus)
0 = FV
Solve for PV = -$389,957 (For the TI BA II Plus, CPT, PV. This number comes up negative because the money will have to come out, not be in the client’s checking account)
Then, to calculate the monthly savings requirement:
Set calculator to END
Key reverse sign “+/-“ to change previous result to positive $389,957, FV
12, Shift, N (should read 144 [12 × 12]) (For the TI BA II Plus: 12, 2ND, xP/Y, N)
8% = I/YR (I/Y for the TI BA II Plus)
0 = PV
Solve for PMT (end of period) = $1,621
LO 8.3.2
Which of these is CORRECT with respect to a 403(b) plan?
A)
Hardship distributions are not allowed from the plan.
B)
Participants in a 403(b) plan are NOT subject to the required minimum distribution rules.
C)
The plan may not accept a rollover of funds from another qualified plan.
D)
The plan may use annuities or mutual funds as funding vehicles.
d
The RMD rules do apply to participants in a 403(b). Hardship distributions are allowed from a 403(b) plan, but are typically subject to income taxation and the 10% premature distribution penalty. A 403(b) plan may use annuities or mutual funds as funding vehicles but may not use individual stocks and bonds. The plan may accept a rollover of funds from a qualified plan, employee salary deferrals, employer contributions, and after-tax employee contributions.
LO 8.2.1
George and Julia anticipate that they will require an annual income of $72,000 (in today’s dollars) when they retire 15 years from now. They expect to receive Social Security benefits of $18,000 per year at that time. In calculating their retirement savings need, they are assuming a 3% annual rate of inflation, an 8% after-tax return on investments, and a 25-year retirement period. What is the total amount of retirement fund or capital that George and Julia will require to support their income needs at the beginning of their retirement? (Round your answer to the nearest dollar.)
A)
$1,261,635
B)
$1,203,226
C)
$1,412,257
D)
$1,356,875
c
The total retirement fund needed by George and Julia is $1,412,257, calculated as follows:
Step 1:
PV = –$72,000
I/YR = 3
N = 15
FV = $112,174
Now deduct the $18,000 of Social Security benefits expected to be received: $112,174 − $18,000 = $94,174. Step 2:
In BEGIN mode:
PMT = $94,174
N = 25
I/YR = 4.8544 [(1.08 ÷ 1.03) − 1 × 100]
PVAD = −$1,412,257
LO 8.3.2
Which of the following is a retirement plan that is not easily understood by employees, the employer assumes the investment risk, favors older plan participants, and does not permit elective deferrals?
A)
Traditional profit-sharing plan
B)
Money purchase plan
C)
Traditional defined benefit plan
D)
Target benefit plan
c The question is describing a traditional defined benefit plan.
LO 8.1.2
The incidental benefit rule provides that term life insurance in a defined contribution plan is limited to
A)
a face value of $50,000 or less.
B)
aggregate annual premiums of less than 50% of the employer’s aggregate contributions to the participant’s account.
C)
aggregate annual premiums of 25% or less of the employer’s aggregate contributions to the participant’s account.
D)
one hundred times the participant’s aggregate annual contribution.
c
The incidental benefit limit provides that term life insurance in a defined contribution plan is limited to aggregate annual premiums of 25% or less of the employer’s aggregate contributions to the participant’s account. No more than 25% of the employer contributions can be used to purchase life insurance other than whole life insurance. The limit for whole life insurance is 50% of the employer contribution.
LO 8.2.2
If the client’s business objectives are to reduce income tax, reward executive employees, retain and recruit employees, and reduce employee turnover, which plan selection approach could address these issues?
A)
A pension plan or a profit-sharing plan
B)
None of these
C)
Pension plan only approach
D)
Profit-sharing only approach
a A pension plan or a profit-sharing plan can address each of these objectives.
LO 8.1.1
Terri is 58 years old. Her company anticipates that the next several years will be profitable, but not extravagant. Terri’s actuary informed her that a defined benefit plan would cost her $100,000 per year. Terri is only willing to put a total of $50,000 into the company’s retirement plan. Most of her workers are 20–35 years old. What type of qualified retirement plan should Terri select?
A)
Money purchase plan
B)
Target benefit plan
C)
Profit-sharing plan
D)
Defined benefit plan
b The best choice for Terri is a target benefit plan. The key is that the owner is older than the workers but cannot afford a defined benefit plan. Also, the firm can afford the mandatory annual contributions.
LO 8.1.1
Which of the following would merit assuming an after-tax rate of return when considered as part of the accumulation strategy in a client’s retirement planning calculations?
Corporate zero coupon bonds held outside a qualified plan or IRA
High dividend paying blue-chip stocks held in a Roth IRA
Aggressive growth mutual funds held in a Section 457 plan sponsored for employees by a tax-exempt organization
Cash value of a variable life insurance policy that is a modified endowment contract (MEC)
A)
II and III
B)
I and IV
C)
I only
D)
IV only
c Only the corporate zero coupon bonds would generate currently taxable income which would merit assuming an after-tax rate of return in the accumulation strategy. The Roth IRA would generate tax-deferred earnings, at worst, but possibly tax-free earnings. The Section 457 plan offers tax-deferred earnings. The cash value of a variable life insurance policy that is a MEC has tax-deferred earnings until distributed as a withdrawal or policy loan.
LO 8.2.1
Which of these plans typically use the percentage test when calculating the amount of life insurance that may be held in the plan for a plan participant?
A)
Traditional defined benefit plan
B)
Traditional profit-sharing plan
C)
Top-hat plan
D)
SEP plan
b Typically, defined contribution plans, such as a traditional profit-sharing plan, use the percentage test. Defined benefit plans typically use the 100 to 1 test.
LO 8.2.2
Richard participates in a traditional defined benefit pension plan at work. His projected monthly benefit under the plan is $1,000. If the plan provides life insurance for Richard, the death benefit payable under the policy is limited to
A)
$215,000.
B)
$52,000.
C)
$17,500.
D)
$100,000.
d Defined benefit plans use the 100 times test for determining whether they comply with the incidental benefit rules. Under this test, the death benefit cannot exceed 100 times the participant’s projected monthly benefit (in this instance, $100,000).
LO 8.2.2
All of these are individual savings alternatives an employed person may typically use to meet his retirement savings goals except
A)
Roth IRAs.
B)
fixed and variable annuities.
C)
nonqualified deferred compensation (NQDC) plans.
D)
traditional IRAs.
c IRAs and annuities are individual savings plan alternatives a client can implement to meet his retirement income goals. NQDC plans are employer-sponsored alternatives.
LO 8.3.1
A retirement plan participant died before retirement, and there is a cost basis associated with her account. Which of the following state the beneficiary’s income tax liability due to death benefits paid from a qualified plan as either life income or installment payments?
When the benefits are from life insurance, the cash value portion is taxed under the annuity rules.
If the benefits are not related to life insurance, the employee’s cost basis becomes the cost basis for the beneficiary.
If the benefits are not related to life insurance, the includible amount is generally taxed as ordinary income.
When the benefits are from life insurance, the amount deemed to be pure insurance is excludible from gross income.
A)
I and II
B)
I, II, III, and IV
C)
III and IV
D)
I and III
b The annuity rules govern the taxation of the cash value portion of the benefits. The beneficiary assumes the employee’s tax basis if the death benefits are not from life insurance. The beneficiary’s cost basis is used to determine the taxable portion of a distribution that does not come from life insurance. Pure insurance death benefits are received income tax free.
LO 8.2.2
Bob and Nancy have analyzed their current living expenses and estimated their lump sum retirement need, net of expected Social Security benefits, to be $5 million in today’s dollars. Their current assets and investments will grow to $3 million at the first retirement year, leaving $2 million to be saved over the preretirement period. They are confident that they can earn a 7% after-tax return on their investments, and they expect inflation to average 4% over the long term. Use the following worksheet to calculate their annual serial (increasing) savings requirement.
(1) Determine the deflated value of the additional savings needed at retirement in today’s dollars:
$ 2,000,000 additional savings need at retirement
25 number of periods until retirement
4% % inflation rate
Deflated value of additional savings need at retirement - $750,234
(2) Determine the amount that Bob and Nancy need to save at the end of the first (current) year. This amount is increased each year during the preretirement period at the inflation rate:
$750,234 deflated value of additional savings need at retirement (from (1))—used as the future value to calculate the first serial (increasing) savings
25 number of periods until retirement
% inflation-adjusted yield determined using:
7% % after-tax return
4% % inflation rate
formula: I/YR = ([(1 + r) ÷ (1 + i)] – 1) × 100
Calculate the first after-tax serial (increasing) savings payment before adjustment for inflation. $_____
(3) Inflation adjustment:
First year unadjusted serial savings required (from (2))
4% % inflation rate
First Year Serial (Increasing) Savings Amount Adjusted For Inflation $_____
What is Bob and Nancy’s first end-of-year savings payment, adjusted for inflation?
A)
$20,305
B)
$20,891
C)
$21,727
D)
$21,117
c The first step in the serial (increasing) savings calculation is to remove the effects of inflation from the given $2 million retirement savings need. Then, with the calculator set for end-of-period payments, the PVOA calculation uses the following inputs: PV = $0, FV = $750,234, N = 25 years, Inflation-adjusted growth rate = 2.8846%. Solve for PMT, then increase this result by one year’s inflation ($20,891 × 1.04 = $21,727).
LO 8.3.2
