Question

Your employer offers a 401k that you can invest in as an employee of the firm....

Your employer offers a 401k that you can invest in as an employee of the firm. If you put in 3% of your pre-tax income (listed in question 1.a.), your employer will match 3%.

  1. Assume you are offered a job with a salary of $40,000 and a bonus of 7.5% based on your performance during the year.
    1. If you receive your full bonus at the end of the year, what is your total (gross) pay for the year?

40,000 + 3,000 = $43,000

a. Assuming you put in the full 3% during your first year of employment, how much will your take home pay be reduced? In other words, what is the difference between your take-home pay without the 401k contribution (from part 1.b.iv.) and your take-home pay after a 401k contribution?\

b. How much will you have saved in total in your 401K account for the year (counting your employer contribution and your contribution)?

c. Assume now that you earn 8% per year on your total contribution (from part 2.b.), how much will that one year of savingsgrow into after 40 more years?

d. How much would the account be worth if you contribute 3% per year, and your employer matches 3%, for 40 years (assuming you earn the same salary and 8% return)?  Consider this question separately from part c.

Homework Answers

Answer #1

(a) Salary = $ 40000, Bonus = 7.5 % of Salary = 40000 x 0.075 = $ 3000

Total Gross Pay = 40000 + 3000 = $ 43000

401k Contribution = 3 % of Total Gross Pay = 0.03 x 43000 = $ 1290

Difference in Take-Home with and without 401k contribution = 401k contribution = $ 1290

(b) Own Contribution = $ 1290, As employer matches 401k contribution by self, total 401k amount after one year = 1290 x 2 = $ 2580

(c) Contribution Value after 1 year = $ 2580, Tenure = 40 years and Rate of Return = 8 %

Total Contribution Value after 40 more years = 2580 x (1.08)^(40) = $ 56049.265

(d) Total Employer + Employee Contribution = 6 % of 43000 = 0.06 x 43000 = $ 2580

Year Contribution = $ 2580, Rate of Return = 8 % and Total Tenure = 40 years

Total Future Worth of Contributions = 2580 x (1.08)^(39) + 2580 x (1.08)^(38) + .............+ 2580 x (1.08) + 2580 = [{(1.08)^(40) - 1}/{1.08 - 1}] x 2580 = $ 668365.8

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