Question

Your company sponsors a 401(k) plan into which you deposit 12 percent of your $70,000 annual income. Your company matches 50 percent of the first 4 percent of your earnings. You expect the fund to yield 8 percent next year. If you are currently in the 31 percent tax bracket.

a.	How many dollars did you invest out of your salary in your 401(k) plan this year?

Annual investment

$

b.	What is your one-year return? (Round your answer to 2 decimal places. (e.g., 32.16))

One-year return

%

Answer 1

a). Employee's Contribution = Annual Income x 12% = $70,000 x 12% = $8,400

Tax Savings = Employee's Contribution x Tax Rate = $8,400 x 0.31 = $2,604

Employee's Cost = Employee's Contribution - Tax Savings = $8,400 - $2,604 = $5,796

Employer's Match = Annual Income x 50% x 4% = $70,000 x 0.5 x 0.04 = $1,400

Total 401(k) investment at year start = Employee's Contribution + Employer's Match

= $8,400 + $1,400 = $9,800

b). 1-year earnings = Total Investment x yield = $9,800 x 0.08 = $784

Total 401(k) investment at year-end = $9,800 + $784 = $10,584

Employee's one year return = [Year-end Investment - Employee's Cost] / Employee's Cost

= [$10,584 - $5,796] / $5,796 = $4,788 / $5,796 = 82.61%