Taxes and Investment Planning for Retirement

Question 1

What are the three steps in our basic retirement planning calculation?

Answer 1

1) How much money do you need to withdraw from your savings each year when you are retired?
2) How much wealth you need at retirement?
3) How much do you need to save each year to accumulate that wealth?

Question 2

How do we incorporate inflation into our calculation?

Answer 2

1) Using current dollars and real rates of return

2) Adjust future cash flows to include inflation and use nominal rates of return.

Question 3

How does the asset allocation decision affect the basic three steps in our retirement planning calculation?

Answer 3

It affects the expected return (and risk) used to calculate the amount you’ll have at retirement and the amount of wealth you’ll need at retirement.

Question 4

What are actions that can reduce the amount we need to save while working?

Answer 4

1) Retire later
2) Live on less during retirement
3) Invest more aggressively (though this brings more risk)

Question 5

Three ways that taxes affect investing

Answer 5

1) Some types of income are taxed differently.
2) Some assets are taxed differently.
3) Some accounts are taxed differently.

Question 6

Under the current tax laws, which are taxed at a higher rate: short-run or long-run capital gains?

Answer 6

Short-run capital gains

Question 7

Capital Gains Distributions

Answer 7

1) Mutual funds that realize capital gains through selling shares must distribute these gains (typically towards the end of the year).
2) Shareholders must pay taxes on these gains even if they did not sell any shares and the distributions are reinvested in the fund

Question 8

Roth IRA

Answer 8

1) Contributions are made with after-tax dollars.
2) Income is not taxed.
3) Individually directed and can invest in most types of assets.

Question 9

Traditional IRA

Answer 9

Individuals can contribute to their account each year with before-tax money.
Taxes are not paid until the money is withdrawn.
Individually directed and can invest in most types of assets.

Question 10

401(k)

Answer 10

1) Accounts are set up with employer.
2) Individuals can contribute to their account each year with pre-tax money.
3) Taxes are not paid until the money is withdrawn.

Question 11

The Asset Location Decision

Answer 11

The determination of what assets go in which account is called the asset location decision.

Ideally, assets generating income subject to the highest tax rate should go in tax-sheltered accounts.