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Growth, terminal value, annual withdrawals, tax impact

This problem uses a tax deferred 401(k) pension plan as the basis for considering the choice among different types of mutual funds.

1. This first question illustrates the large amount to which a modest amount will grow over an extended time period.

Bozena's contribution $1,600
Company's match 800
_______
Total contribution $2,400

PMT = -2400; N = 45; I = 10; PV = 0;
FV = ? = ________(Qs 1)
This is the terminal value.

The interest table for the future value of an annuity does not have 45 years. An alternative means to solve the problem is to compute the interest factor.
FVAIF = (1 + i)^n - 1 = (1 + .1)^45 - 1
--------------- -------------------
i 0.1
= 718.905
The next step is $2,400 X 718.905 = ?

2. If Bozena does not participate in the 401(k) but saves $1,600 annually, she will have considerably less because (1) she does not get the matching funds and (2) her earnings are taxed. Unless she pays the tax obligation from another source of funds, she nets only 8 percent annually. The terminal value is reduced to ___________(Qs 2).
(PMT = -1600; N = 45; I = 8; PV = 0; FV = ?_______) or
FVAIF =(1 + i)^n - 1 = (1 + .08)^45 - 1
---------------- ---------------------
i .08

= 386.506

and $1,600 x 386.506 = ?.

3. In this question Bozena withdraws the funds from the accounts. In the case of the 401(k), the annual withdrawal is

$1,725,372 = X (Interest factor for the present value of an annuity at 10 percent for twenty years)
= X (8.514)
X = ?_______(Qs 3)

(N = 20; I = 10; FV = 0; PV = 1725372; PMT = ?________)

After taxes of $40,530, she nets X - 40,530 = $162,121.

In the case of the funds outside the 401(k) she withdraws less because she has accumulated less and she continues to earn less even after adjusting for taxes. The annual withdrawal is

$618,409 = X (Interest factor for the present value of an annuity at 8 percent for twenty years)
= X(9.818)
X = ?_______(Qs4)

She nets the entire ?________ because the taxes have already been paid. The difference between the two withdrawals is about $100,000 annually.

4. If her salary grows, the amount in the account will also grow. The easiest way to work this problem may be to set up the following spreadsheet using a financial calculator.

Years 1-5 6-10 11-15 16-20 21-25
Salary $32,000 37,000 42,000 47,000 52,000
Contribution $2,400 2,775 3,150 3,525 3,525
N = 5 5 5 5 5
I = 10 10 10 10 10
PV = 0 -14652 -40539 -84520 -157641
PMT = -2400 -2775 -3150 -3150 -3525
FV = 14652 40539 84520 157641 277692

Years 26-30 31-35 36-40 41-45
Salary $57,000 62,000 67,000 72,000
Contribution $4,272 4,650 5,025 5,400
N = 5 5 5 5
I = 10 10 10 10
PV = -277692 -473325 -790683 -1304081
PMT = -4272 -4650 -5025 -5400
FV = 473325 790683 1303081 2133203

The amount in the account now exceeds ___________(Qs 5) million.

Q1______________ Answer
Q2______________ Answer
Q3______________ Answer
Q4______________ Answer
Q5______________ Answer

Solution Summary

Growth, terminal value, annual withdrawls and tax impacts are examined.

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