Question

Tilly would like to invest ​$3, 300 in​ before-tax income each year in a retirement account or in stock investments outside the retirement account. Tilly likes the stock investments outside the retirement account because they provide her with more flexibility and a potentially higher return. Tilly would like to retire in 30 years. If she invests money in the retirement​ account, she can earn 77​% annually. If she invests in stock outside the​ account, she can earn 9​% annually. Tilly is in the 25​% marginal tax bracket.

a. If Tilly invests all her money in the retirement account and withdraws all her income when she​ retires, what is her income after​ taxes?

b. If Tilly invests all her money in stocks outside the​ account, what are her savings at​ retirement? ​(Hint​: Remember that the income is taxed prior to​ investment.)

c. Assuming a capital gains tax rate of 15​%, what is the​ after-tax value of the stock​ investments?

d. Should Tilly invest her money in the retirement account or in stocks outside the​ account?

If Tilly invests all her money in the retirement account and withdraws all her income when she​ retires, her income after taxes is ​$

Answer 1

a). I = 7
N = 30
PV = 0
PMT = 3,300
FV = ?

FV = $311,720.59

Income Tax = $311,720.59 x 0.25 = $77,930.15

Income After Taxes = $311,720.59 - $77,930.15 = $233,790.45

(b) I = 9
N = 30
PV = 0
PMT = $3,300 - ($3,300 X 0.25) = 2,475
FV = ?

FV = $337,361.16

(c)

Purchase Price of Stock = $2,475 X 30 = $74,250

Capital Gain = $337,361.16 - $74,250 = $263,111.16

Capital Gains Tax = $263,111.16 x 0.15 = $39,466.67

Value of Investment = $263,111.16 - $39,466.67 = $223,644.48

(d) Whatever is higher income = Alternative stock investment,i.e., Stocks outside the account.