The Future Value of Tax-Advantaged vs.Taxable Account
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Susan Lee who is 26 years-old has a new job with Inspiron. She is planning to start her own business in 8 years so she has two options to start saving money to open her shop:
1) She can participate in 401K plan that the company offers as part of the employee benefit package. She can afford to contribute $5,000 each year to her 401K plan. Her investment plan earns 10% a year. She estimates her plan balance will be $57,269 keeping in mind that she will contribute 5000 each year at 10 percent.
2) She can save $3,600 each year if she takes her entire salary in cash, pay income tax. Susan won't contribute to her 401k plan for 8 years but she has an investment plan that earns 10 % a year. She estimates that her saving funds in 8 years will be $37,304 because her annual income is taxable, her saving account will mature at 7.2%.
Please show the calculations for each of the option and explain which of these two options have the greatest after-tax cash to start a business (Susan has a constant 28% tax rate)
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Solution Summary
Given a taxpayer's option to invest in a tax-advantaged or taxable account, this solution illustrates how to compute the financial advantage of the former over the latter.
Solution Preview
See attached Excel file.
Susan has an advantage in using the 401(k) plan which the problem does not even address. That is, she invests $5,000 per year but receives a tax ...
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