Retirement Planning



Retirement Planning Worksheet

1. What is a 401K? What are the benefits of a 401K?

2. What is a Traditional IRA—Individual Retirement Account?

What are the benefits?

What is the maximum contribution?

3. What is a Roth IRA?

What are the benefits?

What is the maximum contribution?

4. To contribute to an IRA, you must have _____________________________?

5. You and your friend, Elmo, have the opportunity to participate in the employer’s 401K plan. If an employee contributes at least 5% of his/her salary, the company will contribute 5%. Both of you are 25 years old, have annual salaries of $50,000, are single and expect taxable income of $40,000 this year if you do not contribute to your 401K. You decide to contribute 5%; Elmo contributes nothing but invests elsewhere the same amount as what you contribute to the 401K. Assume a 10% annual pre-tax return, no state income taxes; assume all contributions are made at the end of the year. Answer the following questions for both Elmo and you.

a. savings at the end of the first year

b. At the end of the first year, how much more money will you have compared to Elmo?

c. How much will the one year investment equal in 40 years? Assume in 40 years you “cash-out” your 401K and pay tax at the rate of 25%. Assume capital gains taxes are 15% a year on any profit outside a 401K.

d. If Elmo and you continue your investment and retirement strategy every year for the next 40 years (assuming no raise or tax policy changes), how much would you and Elmo have in 40 years?

e. What are the lessons from this problem?

6. You have an opportunity to invest in a Roth IRA or a tax deductible traditional IRA. In either case, you would contribute $5,000. You are in the 25% tax bracket. You plan to retire in 45 years. At this time, you will withdraw all of your retirement savings. You expect to be in the 30% tax bracket at the time of retirement. You expect a 10% annual return. With the traditional IRA, assume you invest the tax savings tax deferred for 45 years. That is, you buy stock and do not sell it for 40 years and pay the tax at that time. Should you invest in the Roth IRA or traditional IRA? Show your work.

7. You are 22 and decide to start saving for retirement by opening up a Roth IRA with an initial contribution of $5,000. To be conservative, assume you deposit this same amount at the END of every year for 43 years. Dixon (22 years old) follows the same investment philosophy as you but starts contributing when he is 32 years old. Therefore, Dixon contributes for 33 years. Assume a 10% annual return. How much will you and Dixon have at the age of 65? What is the lesson?

8. You are 22 and decide to start saving for retirement by opening up a Roth IRA with an initial contribution of $5,000. To be conservative, assume you deposit this same amount at the END of every year for 43 years. Assume a 10% annual return. How much will you have at the age of 65? If you make your contribution at the BEGINNING of each year (January 1), how much will you have at the end of 43 years? What is the lesson?

9. You are 22 and decide to start saving for retirement by opening up a Roth IRA with an initial contribution of $5,000. To be conservative, assume you deposit this same amount at the END of every year for 43 years. Assuming a 10% annual return, how much will you have at the age of 65? Assuming a 9% annual return, how much will you have at the age of 65? What is the lesson?

10. What are the strengths and weaknesses of variable annuities?

Strengths: tax-deferred income

Weaknesses: convert capital gains to ordinary income when funds are withdrawn; potentially high fees (2-3%), 10% penalty if you withdraw funds before the age of 59.5

11. What factors must be considered to determine how much money you need for retirement? Understand the link—Estimating Your Net Worth for Retirement/Estimating Your Future Retirement Needs

12. Why do we need to be concerned with using “average annual returns”? Hint: Monte Carlo

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