Deck 34: Taxes and Investment Planning

Question 1

Examples of the Exempt Model include deductible IRAs,H.R.10 (Keogh)plans,Sec.401(k)plans,and tax deferred annuities.

Answer 1

False

Question 2

In the Current Model,investment earnings are taxed as they are earned.

Answer 2

True

Question 3

The Deferred Model offers two levels of tax deferral-the original contribution escapes current taxation as do the earnings on the underlying investment.

Answer 3

False

Question 4

Investments conforming to the Current Model provide no deferral advantages because earnings are taxed currently.

Question 5

A taxpayer in the 24% marginal tax bracket invests $1,000 of after-tax dollars at 10% interest before taxes.At the end of year one,the taxpayer will have accumulated after-tax dollars of $1,076.

Question 6

The nondeductible traditional IRA is a classic example of the Pension Model.

Question 7

In the Exempt Model,the earnings are excluded from explicit taxation.

Question 8

The Roth IRA is an example of the Pension Model.

Question 9

In the Deferred Model,only after-tax dollars are invested.

Question 10

Under the Pension Model,the entire accumulation,not just the earnings,is taxed at the end of the investment horizon.

Question 11

A single taxpayer earns a salary of $6,000.If he is taxed with a 10% flat rate,he has $5,400 of after-tax dollars available to invest.

Question 12

In the Deferred Model,both the initial investment dollars and the investment earnings are taxed at the end of the investment period.

Question 13

One of the characteristics of the Exempt Model is that earnings on the investment are exempt from explicit taxation.

Question 14

An investment in a growth stock which does not pay dividends is an example of the Exempt Model.

Question 15

The Deferred Model investment outperforms the Current Model investment if interest rates and tax rates are constant over time because the interest on the Deferred Model investment grows tax free until withdrawal.

Question 16

Employer-sponsored qualified retirement plans and deductible IRAs fit the Pension Model.

Question 17

One characteristic of the Exempt Model is the fact that,like the Current and Deferred Models,only after-tax dollars are invested.

Question 18

In the Pension Model,the initial investment is deductible or excludible from gross income,and investment earnings are taxed currently.

Question 19

Savings accounts and money market funds are examples of investments taxed under the Current Model.

Question 20

One characteristic of the Pension Model is the fact that,like the Current and Deferred Models,only after-tax dollars are invested.

Question 21

Nolan earns a salary of $80,000 and has a flat tax rate of 28%.The amount of after-tax dollars he has to invest is

A)$22,400.
B)$57,600.
C)$56,000.
D)$80,000.

Question 22

Vidya can invest $5,000 of after-tax dollars (AT$)directly in a taxable bond outside an IRA,or he can contribute the $5,000 to a nondeductible IRA and invest in the same bond through the IRA vehicle.In either case,the bond yields an annual 5% before-tax rate of return (BTROR).Vidya's marginal tax rate is 15%,and he expects it to remain so for the entire investment horizon of 20 years.What is the after-tax accumulation for the "bond inside the IRA" after 20 years?

A)$12,027
B)$11,277
C)$10,062
D)None of the above.

Question 23

In the Deferred Model

A)investment earnings are taxed currently.
B)investment earnings are exempt from explicit taxation.
C)investment earnings are taxed at the end of the investment period.
D)the initial investment is deductible or excludible from gross income,and the entire accumulation is taxed at the end of the investment period.

Question 24

In the Exempt Model

A)investment earnings are taxed currently.
B)investment earnings are exempt from explicit taxation.
C)investment earnings are taxed at the end of the investment period.
D)the initial investment is deductible or excludible from gross income,and the entire accumulation is taxed at the end of the investment period.

Question 25

If "R" equals the before-tax rate of return and "t" equals the investor's marginal tax rate,then the after-tax rate of return represented by "r" can be expressed as

A)r = R(1 - t).
B)r = R(1 + t).
C)r = (1 + t)^R.
D)r = R - t.

Question 26

The investment models discussed in the text include all of the following except for

A)the Deferred Model.
B)the Pension Model.
C)the Exempt Model.
D)the Equilibrium Model.

Question 27

Rich,an individual investor,lives in a land of no taxation and receive a $10,000 bonus.He invests this amount in a bond that pays interest of 4% per year and holds the bond for 5 years,reinvesting the interest annually at the same 4% return.At the end of 5 years the $10,000 original investment accumulates to

A)$10,400.
B)$12,625.
C)$12,763.
D)$12,167.

Question 28

The general form of the annualized after-tax rate of return (annualized ATROR)for the Deferred Model can be expressed as

A)r_ann = [(1 + R)ⁿ(1 - t_n)+ t_n]^1/n - 1.
B)r_ann = [(1 - R)ⁿ(1 - t)+ t]^1/n - 1.
C)r_ann = [(1 + R)ⁿ(1 + t)+ t]^1/n - 1.
D)r_ann = [(1 + R)ⁿ(1 + t)- t]^1/n - 1.

Question 29

Charlene can invest $4,000 of after-tax dollars (AT$)directly in a taxable bond outside an IRA,or she can contribute the $4,000 to a nondeductible IRA and invest in the same bond through the IRA vehicle.In either case,the bond yields an annual 7% before-tax rate of return (BTROR).Charlene's marginal tax rate is 20%,and she expects it to remain so for the entire investment horizon of 25 years.What is her annualized after-tax rate of return (annualized ATROR)for the "bond outside the IRA"?

A)5)6%
B)6%
C)6)5%
D)7%

Question 30

Which of the following is a classic example of the Deferred Model?

A)a deductible traditional IRA
B)a 401(k)plan
C)a H.R.10 (Keogh)plan
D)a nondeductible traditional IRA

Question 31

At the beginning of year 1,Sandeep invests $10,000 in a money market fund that pays a 3% annual return before taxes.Sandeep's marginal tax rate is 25%,and he allows the after-tax earnings to remain in the money market fund.That is,he withdraws only enough cash to pay the taxes on the earnings.What is his after-tax accumulation at the end of year 2?

A)$10,455
B)$10,609
C)$10,690
D)None of the above

Question 32

Miles invests $20,000 in a taxable bond for 5 years that earns 5% interest per year.His marginal tax rate is 15%.What is his after-tax accumulated investment at the end of year 1?

A)$20,850
B)$21,000
C)$21,700
D)$22,000

Question 33

In the Pension Model

A)investment earnings are taxed currently.
B)investment earnings are exempt from explicit taxation.
C)investment earnings are taxed at the end of the investment period.
D)the initial investment is deductible or excludible from gross income,and the investment earnings are taxed at the end of the investment period.

Question 34

Kate can invest $4,000 of after-tax dollars (AT$)directly in a taxable bond outside an IRA,or she can contribute the $4,000 to a nondeductible IRA and invest in the same bond through the IRA vehicle.In either case,the bond yields an annual 3% before-tax rate of return (BTROR).Kate's marginal tax rate is 15%,and she expects it to remain so for the entire investment horizon of 25 years.What is the after-tax accumulation for the "bond outside the IRA" after 25 years (assume that bond interest is reinvested at the same rate)?

A)$5,585
B)$7,507
C)$8,375
D)None of the above

Question 35

When given a choice between making a contribution to a Roth IRA or to a nondeductible traditional IRA,the taxpayer should choose the Roth IRA.

Question 36

Heidi invests $1,000 in a taxable bond for 5 years that earns 4% interest per year.Her marginal tax rate is 15%.What is her after-tax accumulated investment at the end of year 5 (assume that bond interest is reinvested at the same rate)?

A)$1,182
B)$1,143
C)$1,020
D)$1,762

Question 37

Jan can invest $4,000 of after-tax dollars (AT$)directly in a taxable bond outside an IRA,or she can contribute the $4,000 to a nondeductible IRA and invest in the same bond through the IRA vehicle.In either case,the bond yields an annual 4% before-tax rate of return (BTROR).Jan's marginal tax rate is 15%,and she expects it to remain so for the entire investment horizon of 25 years.What is her annualized after-tax rate of return (annualized ATROR)for the "bond inside the IRA"?

A)3)6%
B)4)5%
C)4%
D)None of the above

Question 38

The Current Model provides the future value of an investment having which of the following characteristics?

A)only after-tax dollars are invested
B)only before-tax dollars are invested
C)the earnings on the investment are taxed at the end of the investment period
D)investment earnings are exempt from taxation

Question 39

In the Current Model

A)investment earnings are taxed currently.
B)the initial investment is taxable currently,and the investment earnings are taxed at the end of the investment period.
C)investment earnings are exempt from explicit taxation.
D)the initial investment is deductible or excludible from gross income,and the entire accumulation is taxed at the end of the investment period.

Question 40

The Deferred Model has all of the following characteristics except for

A)only after-tax dollars are invested.
B)the earnings on the investment are not taxed annually.
C)the accumulated earnings are taxed at the end of the investment horizon.
D)the Deferred Model will not outperform the Current Model given equal BTRORs and constant tax rates.

Question 41

Taxpayers often have to decide between contributing to a traditional deductible IRA or a Roth IRA.In making the comparison between the two IRAs,which models should the taxpayer use?

A) $\begin{array}{|l|l|}\hline\text { Traditional } IRA& \text { Roth IRA } \\\hline \text { Deferred Model } & \text { Pension Model }\\\hline\end{array}$
B) $\begin{array}{|l|l|}\hline\text { Traditional } IRA& \text { Roth IRA } \\\hline \text { Exempt Model } & \text { Deferred Model }\\\hline\end{array}$
C) $\begin{array}{|l|l|}\hline\text { Traditional } IRA& \text { Roth IRA } \\\hline \text { Pension Model } & \text { Deferred Model }\\\hline\end{array}$
D) $$\begin{array} {| l | l |} \hline\text { Traditional IRA } & \text { Roth IRA } \\\hline \text { Pension Model } & \text { Exempt Model } \\\hline\end{array}$$

Question 42

The source of funds used to pay the taxes upon conversion of a traditional IRA to a Roth IRA can influence the decision.Use of funds from the IRA to pay the conversion tax is likely to bias the decision towards converting.

Question 43

Will invests $20,000 of after-tax dollars (AT$)in tax-exempt municipal bonds which yield 5% per year.He reinvests the interest in the same bonds and holds the bonds for two years.Will's marginal tax rate is 25%.What is his after-tax accumulation at the end of two years?

A)$21,000
B)$21,528
C)$22,000
D)$22,050

Question 44

The C Corporation Model is a variation of the Pass-Through Model,where taxation occurs at both the entity and the owner levels.

Question 45

Taxpayers often have to decide between contributing to a traditional nondeductible IRA or a Roth IRA.In making the comparison between the two IRAs,which models should the taxpayer use?

A) $$\begin{array} { | l | l | } \hline \text { Traditional Nondeductible } & \\\text { IRA } & \text { Roth IRA } \\\hline \text { Deferred Model } & \text { Exempt Model } \\\hline\end{array}$$
B) $$\begin{array} { | l | l | } \hline \text { Traditional Nondeductible } & \\\text { IRA } & \text { Roth IRA } \\\hline \text { Exempt Model } & \text { Deferred Model } \\\hline\end{array}$$
C) $$\begin{array} { | l | l | } \hline \text { Traditional Nondeductible } & \\\text { IRA } & \text { Roth IRA } \\\hline \text { Pension Model } & \text { Deferred Model } \\\hline\end{array}$$
D) $$\begin{array} { | l | l | } \hline \text { Traditional Nondeductible } & \\\text { IRA } & \text { Roth IRA } \\\hline \text { Pension Model } & \text { Exempt Model } \\\hline\end{array}$$

Question 46

A taxpayer has a traditional IRA and is considering converting it to a Roth.Which of the following conditions is likely to discourage the conversion?

A)The taxpayer has a significant tax basis in the IRA from non-deductible contributions.
B)The taxpayer has no expected need for distributions after retirement due to significant other investment accounts and a pension from work
C)The taxpayer expects lower tax rates in the future.
D)The taxpayer plans to continue working part-time into her seventies and would like to continue contributing to an IRA.

Question 47

Which of the following characteristics belong(s)to the Exempt Model?

A)Only after-tax dollars are invested.
B)Only tax-free dollars are invested.
C)Earnings on the investment are exempt from explicit taxation.
D)both A and C

Question 48

If t₀ is the tax rate in Year 0,t_n is the tax rate in Year n,and ATA is after-tax accumulation,then which one of the following does not hold true?

A)if t₀ = t_n,ATA per Exempt Model = ATA per Pension Model
B)if t₀ > t_n,ATA per Exempt Model < ATA per Pension Model
C)if t₀ < t_n,ATA per Exempt Model > ATA per Pension Model
D)if t₀ > t_n,ATA per Exempt Model > ATA per Pension Model

Question 49

As long as the rollover from a traditional IRA to a Roth IRA is completed within 60 days,no tax is due.

Question 50

In weighing whether to convert a traditional IRA to a Roth IRA,the expectation of lower tax rates at retirement is likely to bias the decision towards retaining the traditional IRA.

Question 51

The Current Model most closely describes a pass-through entity while a variation of the Deferred Model describes a C corporation.

Question 52

The Pension Model has all of the following characteristics except for

A)before-tax dollars are invested.
B)the annual earnings on the investment grow at the before-tax rate of return.
C)only the accumulated earnings are taxed at the end of the investment horizon when the investor cashes out of the investment.
D)the entire accumulation is taxed at the end of the investment horizon when the investor cashes out of the investment.

Question 53

Sylvia makes a one-time $2,000 deductible contribution into a deductible traditional IRA account,which will earn 8% annually before taxes.Twenty-five years later,at age 65,she withdraws all of the accumulation from the IRA when she is in the 15% marginal tax bracket.What is the total of her after-tax accumulated proceeds from the IRA?

A)$6,000
B)$8,541
C)$11,642
D)$13,697

Question 54

In evaluating whether to convert a current traditional IRA to a Roth IRA,a taxpayer will utilize the Deferred and Exempt Models.

Question 55

State and local government obligations such as municipal bonds are classic examples of which model?

A)Deferred Model
B)Exempt Model
C)Current Model
D)Pension Model

Question 56

The Pass-Through Model applies to a sole proprietorship.

Question 57

A pass-through entity's primary characteristic is that income escapes taxation at the entity level and passes through to be taxed at the ownership level.

Question 58

Common examples of the Pension Model include all of the following except for

A)H)R.10 (Keogh)plans.
B)401(k)plans.
C)nondeductible traditional IRAs.
D)tax deferred annuities or 403(b)plans.

Question 59

The formula for the after-tax accumulation (ATA)for the Exempt Model is

A)ATA = AT$ (1 - t)ⁿ.
B)ATA = AT$ (1 + t)ⁿ.
C)ATA = AT$ (1 + R)ⁿ.
D)ATA = AT$ (1 - R)ⁿ.

Question 60

Pass-through entities include partnerships,limited liability companies,limited liability partnerships,and C corporations.

Question 61

The C Corporation Model is a variation of the

A)Current Model.
B)Pension Model.
C)Exempt Model.
D)Deferred Model.

Question 62

An individual is planning to establish a new corporation and is weighing the choice between the C corporation form and the S corporation form.She expects the corporation to be profitable each year,with all profits reinvested except to the extent needed to pay corporate taxes or shareholder taxes on profits.The shareholder's plan is to sell the business after six years for a substantial gain.Factors to consider in modelling the entity choice include all of the following except

A)the individual's ordinary income and capital gains tax rates.
B)the shareholder's eligibility for the qualified business income deduction.
C)the availability of the Sec.1202 exclusion.
D)all of the factors must be considered in the modelling.

Question 63

If a fully-taxable bond yields a BTROR of 10% (R_b = 10%)and a tax-exempt bond of similar risk earns a BTROR of 7.5% (R_f = 7.5%),then the implicit tax rate is

A)25%.
B)75%.
C)10%.
D)none of the above.

Question 64

The Pass-Through Model used for S corporations and partnerships is an application of the

A)Pension Model.
B)Current Model.
C)Deferred Model.
D)Exempt Model.

Question 65

Pass-through entities include all of the following types of entities except

A)partnerships.
B)C corporations.
C)S corporations.
D)limited liability companies (LLCs).

Question 66

A taxpayer has a traditional IRA and is considering converting it to a Roth.Which of the following factors does not bias the decision towards the Roth conversion?

A)A high tax rate expected for the future withdrawal year compared to the tax rate in the conversion year.
B)The ability to use funds outside the IRA to pay the conversion tax.
C)A high ratio of IRA basis to IRA value.
D)All of the above factors favor the Roth conversion.

Question 67

In a progressive tax system,an investor can benefit from tax-exempt bonds when

A)the investor's marginal tax rate is equal to that of the marginal investor.
B)the investor's marginal tax rate exceeds that of the marginal investor.
C)the investor's marginal tax rate is less than that of the marginal investor.
D)none of the above.

Question 68

If a fully-taxable bond yields a BTROR of 8% (R_b = 8%)and a tax-exempt bond of similar risk earns a BTROR of 5% (R_f = 5%),then the implicit tax is

A)3%.
B)5%.
C)8%.
D)none of the above.

Question 69

Given a choice between a fully-taxable investment and a tax-favored investment,investors will prefer the tax-favored investment,assuming the two investments are equally risky.

Question 70

While tax-exempt bonds are not subject to income tax under the Internal Revenue Code,they are subject to implicit taxes caused by increased demand driving up the price.

Question 71

The difference between the BTRORs of fully-taxable and tax-favored investments is called

A)an explicit tax.
B)an implicit tax.
C)an effective tax.
D)a marginal tax.

Question 72

Which of the following statements regarding implicit taxes and clienteles is not true?

A)Market forces drive down the BTROR of tax-favored assets.
B)The reduced return of tax-favored assets is an implicit tax.
C)Investors whose tax rate exceeds that of the marginal investor can reap some benefit through the clientele effect.
D)Marginal investors will always benefit from the implicit tax on tax-favored investments.