Deck 21: Taxes,inflation,and Investment Strategy

Question 1

A person in excellent health with a long life expectancy chooses a lifetime annuity.This is an example of _________.

A) moral hazard
B) adverse selection
C) a Texas hedge
D) actuarial error

Answer 1

B

Question 2

You can tax shelter only one-half of your retirement savings.You want to invest one-half of your savings in bonds and one-half in stocks.How much of the bonds and how much of the stocks should you allocate to the tax sheltered investment?

A) Stock and bond investments should be equally invested in both tax sheltered and non-sheltered accounts.
B) You should place all the stocks in tax sheltered accounts and all the bonds in non-sheltered accounts.
C) You should place all the bonds in tax sheltered accounts, and all the stocks in non-sheltered accounts.
D) It makes no difference how you allocate your stock and bond investments among tax sheltered and non-sheltered accounts.

Answer 2

C

Question 3

No taxes are paid on withdrawals made during retirement from a _________.

A) traditional IRA
B) Roth IRA
C) 401k
D) 403b plan

Answer 3

B

Question 4

The tax effect of a traditional IRA is to _____ taxes.

A) evade
B) postpone
C) erase
D) avoid

Question 5

Annuity income is positively correlated with ___________.
I)longevity
II)durability of marriage
III)expected length of your base (Social Security)annuity

A) I only
B) I and II only
C) II and III only
D) I, II and III

Question 6

In a private defined benefit pension plan the ___________ bears the investment risk and in a private defined contribution plan the ____________ bears the investment risk.

A) plan sponsor; employee
B) employee; plan sponsor
C) U.S. government; plan sponsor
D) plan sponsor; U.S. government

Question 7

Social Security is ____________.

A) a pension plan only
B) an insurance plan only
C) a combination of a pension and insurance plan
D) an involuntary intergenerational transfer

Question 8

A decrease of 1% in both your tax exemption and your income tax rate would on net _______________.

A) make you better off
B) make you worse off
C) make you neither better off or worse off
D) make you either better or worse off depending on your age

Question 9

Which one of the following represents local consumption smoothing?
I)Saving during your working years for retirement
II)Borrowing money to buy a car
III)Putting off a vacation for a year until you can afford it

A) I only
B) II and III only
C) I and II only
D) I, II and III

Question 10

You have the broadest choice of investment alternatives for your _____________.

A) traditional IRA
B) Roth IRA
C) 401k plan
D) taxable savings account

Question 11

If you wish to tilt your savings toward later years you might be well advised to purchase which of the following types of readily available insurance?

A) Career failure insurance
B) Disability insurance
C) Unemployment insurance
D) Moral hazard insurance

Question 12

Inflation has an adverse effect on your savings because ____________.
I)it erodes the purchasing power of the dollars you have saved
II)it increases the real rate of return on the dollars you save
III)unless sheltered,it increases the taxes owed on investment income

A) I only
B) II and III only
C) I and III only
D) I, II and III

Question 13

Contributions to a _____________ are not tax deductible.

A) traditional IRA
B) Roth IRA
C) 401k plan
D) 403b plan

Question 14

You earn 6% on your corporate bond portfolio this year and you are in a 25% federal tax bracket and an 8% state tax bracket.Your after tax return is _____.(Assume that federal taxes are not deductible against state taxes and vice versa).

A) 4.50%
B) 4.14%
C) 4.02%
D) 3.12%

Question 15

Which one of the following is an example of "global" consumption smoothing?

A) Borrowing to buy a car
B) Borrowing to buy a home
C) Saving to send children to college
D) Saving during your working years for retirement

Question 16

The U.S.income tax code is generally _____.

A) regressive
B) progressive
C) flat
D) peaked

Question 17

The solvency of Social Security is threatened by ______________.

A) growing population longevity
B) above replacement growth of the U.S. population
C) Medicare spending
D) the growth of competing defined contribution plans

Question 18

A person in poor health trying to buy supplemental health insurance is an example of ________.

A) moral hazard
B) adverse selection
C) a Texas hedge
D) actuarial error

Question 19

Tax shelters __________________.

A) postpone payment of tax liabilities
B) decrease investment risk
C) increase the pre-tax rate of return earned
D) benefit the government more than the investor

Question 20

The Social Security system _______________.

A) is financed in a regressive way
B) is regressive in the way it allocates benefits
C) is progressive in the way it is financed
D) is fully funded for the foreseeable future

Question 21

As you get older you decide to reduce the risk level of your retirement portfolio because your portfolio is nearing your minimum acceptable level.As the portfolio does better you reallocate funds into higher risk categories.You are practicing a form of ____________.

A) manipulating tax shelters
B) involuntary, intergenerational transfers
C) excessive savings
D) dynamic hedging

Question 22

A study by Spivak and Kotlikoff (1981)showed that a marriage contract increases the dollar value of lifetime savings by as much as _____.

A) 5%
B) 10%
C) 25%
D) 50%

Question 23

Taxes are applied to the _______________________.

A) real value of sheltered investment income
B) nominal value of unsheltered investment income
C) nominal value of sheltered investment income
D) real value of unsheltered investment income

Question 24

Withdrawals from a traditional IRA prior to age ___ are taxable and must pay a ___ tax penalty.

A) 59 ½; 10%
B) 62; 5%
C) 65; 7 ½ %
D) 63 ½; 5%

Question 25

In 2009,the income cap on social security taxes was set at _____ with an exemption of _____.

A) $200,000; $10,000
B) $153,600; $7,600
C) $106,800; $0
D) $96,000; $10,000

Question 26

It would be costly to provide wage insurance because of the ___________ problem.

A) moral hazard
B) adverse selection
C) Texas hedge
D) actuarial error

Question 27

How many years of Social Security contributions count for determination of benefits?

A) 25
B) 35
C) 45
D) All yearly contributions count

Question 28

An IRA-style tax shelter will defer ______________ taxes on contributions and investment earnings.

A) income
B) sales
C) property
D) estate

Question 29

If your marginal tax rate is 15% your capital gains tax rate on a stock you have held for 10 years would be ___.

A) 5%
B) 15%
C) 20%
D) 27.5%

Question 30

Which one of the following is not likely to be subject to adverse selection?

A) Health insurance providers
B) Lifetime annuity providers
C) Life insurance providers
D) Social Security

Question 31

The Social Security Primary Insurance Amount formula favors ______.

A) older workers
B) high income workers
C) younger workers
D) low income workers

Question 32

Under current rules most workers will have ________ of their salary deducted to pay for Social Security.

A) 1.45
B) 6.2%
C) 7.65%
D) 15.3%

Question 33

Contributions to a traditional IRA are __________ and contributions to a Roth IRA are ____________.

A) not tax deductible; not tax deducible
B) tax deductible; tax deductible
C) tax deductible; not tax deductible
D) not tax deductible; tax deductible

Question 34

A saver who expects to have a higher tax rate after retirement would prefer a ______.

A) Roth IRA
B) traditional IRA
C) 401k plan
D) 403b plan

Question 35

Employers commonly match at least some portion of employee contributions to ___________.
I)401k plans
II)403b plans
III)Self directed IRAs

A) I only
B) I and II only
C) II only
D) I, II and III

Question 36

You earned 8% on your corporate bond portfolio this year and you are in a 15% federal tax bracket.If over your holding period inflation was 3% your real after-tax rate of return was _____.

A) 6.80%
B) 3.69%
C) 4.91%
D) 4.25%

Question 37

Tilting your retirement savings plan toward your later years should only be done by investors _____________.

A) who are sufficiently risk averse
B) who are more tolerant of risk
C) who are unsure if their income growth will keep up with inflation
D) who wish to retire early

Question 38

The Average Indexed Monthly Income is used to compute ___________.

A) the consumer price index
B) your Social Security retirement benefits
C) your maximum 401k contribution
D) your maximum IRA contribution

Question 39

Today most employees receive retirement benefits in the form of ________.

A) SEPs
B) defined benefit plans
C) defined annuity plans
D) defined contribution plans

Question 40

One way to hedge labor income is to ____________________.

A) diversify your investment portfolio away from the industry in which you work
B) save for retirement only from investment income
C) change careers every 7 years
D) invest heavily in the stock options provided by your firm

Question 41

Suppose you have maxed out your allowable contributions to your tax sheltered retirement plans and you still want to shelter income.The best choice of investment for you to minimize the tax bill is to invest in _________.

A) a bond portfolio
B) stocks with high dividend yields
C) a blended stock and bond portfolio containing zero coupon bonds
D) stocks with low or zero dividend yields

Question 42

A worker plans to retire in 30 years.He hopes to receive $65,000 per year in retirement income.If inflation is forecast at 2.5% per year,what annual income should he plan to receive in the first year of retirement in order to maintain the purchasing power on $65,000?

A) $65,000
B) $76,159
C) $98,398
D) $136,342

Question 43

In planning for retirement,an investor decides she will save $2,000 every year for 25 years.At a 7% return on her investment,how much money will she have at the end of 25 years?

A) $119,015
B) $125,316
C) $126,498
D) $128,420

Question 44

Statistics show that life expectancy at age 65 for males is about ___ years and for females is about ___ years.

A) 15; 19
B) 17; 20
C) 18; 22
D) 19; 24

Question 45

A worker plans to retire in 20 years.He needs $20,000 per year in retirement income in today's dollars.If inflation is forecast at 3.5% per year,what annual income should he plan to receive in the first year of retirement in order to maintain the purchasing power on $20,000?

A) $30,353
B) $34,159
C) $37,398
D) $39,796

Question 46

Which one of the following statements about 401(k)plans is not correct?

A) The employer will typically match some portion of an employee's contributions to a 401(k).
B) A 401(k) plan is a defined contribution plan.
C) Allowable contributions to 401(k) plans are limited.
D) Withdrawals from 401(k) plans are not taxed upon retirement.

Question 47

A safe driver who drives faster as a result of purchased collision car insurance would be an example of the ___________ problem.

A) moral hazard
B) adverse selection
C) Texas hedge
D) actuarial error

Question 48

A bond and a stock portfolio both provided unrealized pretax return of 8% to a taxable investor.If the stocks paid no dividends we know that the ________.

A) after-tax return of the stock portfolio was higher than the after-tax return of the bond portfolio
B) after-tax return of the bond portfolio was higher than the after-tax return of the stock portfolio
C) after-tax income of the stock portfolio was equal to the after-tax income of the bond portfolio
D) after-tax income of the stock portfolio could have been higher or lower than the after-tax income of the bond portfolio depending on the marginal tax rate of the investor

Question 49

An employee uses his firm's 401(k)plan.If he decides to contribute $11,000 per year and pays an effective tax rate for all items at 28%,what is the reduction in her take home pay each year?

A) $3,080
B) $4,210
C) $7,920
D) $11,000

Question 50

An insurance company plans to sell annuities to investors.Based on actuarial calculations,an investor has a 15 year life span and they want a $30,000 per year annuity,payable at the end of each year.If the insurance company uses a 4% assumed investment rate,how much should the annuity cost?

A) $296,928
B) $312,236
C) $333,552
D) $353.982

Question 51

The employees of a firm complain that they can not afford to contribute $8,000 per year to a 401k,because of the loss of $8,000 of take home pay.In fact,how much will the take home pay be reduced if all taxes combined total 33%?

A) $5,360
B) $6,340
C) $7,637
D) $8,000

Question 52

An investor plans to retire at age 60,with a total savings of $1,000,000.If she is currently 35 years old,has no savings,and expects to earn 8% per year on her investments,how much money must she set aside every year?

A) $15,546
B) $13,679
C) $11,892
D) $10,324

Question 53

Withdrawals after retirement from a traditional IRA are __________ and withdrawals after retirement from a Roth IRA are ____________.

A) taxable; not taxable
B) not taxable; taxable
C) tax deductible; not tax deductible
D) not tax deductible; tax deductible

Question 54

An investor must decide between putting $2,000 into a regular IRA or put $1,440 into a Roth IRA.If the investor's tax rate is 28% now and in retirement,and she expects to earn 12% per year over the next 20 years,which will produce more cash in the end?

A) The investment in the regular IRA
B) The investment in the Roth IRA
C) Both investments will have the same future value after taxes
D) There is not information to determine which will produce the most cash

Question 55

An insurance company plans to sell annuities to investors.Based on actuarial calculations,an investor has a 20 year life span and they want a $50,000 per year annuity,payable at the end of each year.If the insurance company uses a 3% assumed investment rate,how much should the annuity cost?

A) $696,928
B) $743,874
C) $833,552
D) $953.982

Question 56

A regular IRA requires taxes be paid at the time the money is removed from the plan.What is the after-tax value of a $5,000 deposit into an IRA today that generates an 8% return for 20 years if the investor is taxed at the 28% level?

A) $16,779
B) $20,135
C) $21,685
D) $23,305

Question 57

An investor has an effective tax rate on all items of 30% and he decides to put $8,000 into a 401(k).The future value of the investment that results from the deferral of taxes over 30 years at an 8% return equals _____________.

A) $2,400
B) $8,000
C) $10,400
D) $24,150

Question 58

In planning for retirement,an investor decides she will save $11,000 every year for 40 years.At an 11% return on her investment,how much money will she have at the end of 40 years (to the nearest hundred thousand dollars)?

A) $1,400,000
B) $2,800,000
C) $4,900,000
D) $6,400,000

Question 59

What is the value of a $2,500 payment into an IRA,if the investment earns 12% per year for 15 years?

A) $12,174
B) $13,684
C) $14,652
D) $15,523

Question 60

If you start saving for retirement only in your later years and your income growth from that point is rapid then ________________________.

A) a traditional IRA is probably a better choice than a Roth IRA
B) a Roth IRA is probably a better choice than a traditional IRA
C) a SEP is probably a better choice than Medicare
D) a 401(k) is probably a better choice than a 403(b)

Question 61

A non-profit organization offers a 5% salary contribution to John's 403b plan and matching 5% when John contributes 5% of his/her salary. John makes $56,000 a year.
What is John's total cost of his 5% contribution?

A) $2,100 cost
B) $2,800 cost
C) $700 benefit
D) $3500 benefit

Question 62

A non-profit organization offers a 5% salary contribution to John's 403b plan and matching 5% when John contributes 5% of his/her salary. John makes $56,000 a year.
What is John's effective salary reduction if he is in the 25% tax bracket?

A) $2,100
B) $2,800
C) $5,600
D) $8,400

Question 63

A non-profit organization offers a 5% salary contribution to John's 403b plan and matching 5% when John contributes 5% of his/her salary. John makes $56,000 a year.
What is the amount of total contribution to his 403b if John contributes 5% of his own money?

A) $5,600
B) $8,400
C) $11,200
D) $12,500

Question 64

The fact that the U.S.government provides deposit insurance to banks creates a form of ___________ which is at least partially offset by requiring banks to hold more capital if they are riskier.

A) moral hazard
B) adverse selection
C) risk aversion
D) interest rate risk

Question 65

Sharon decides to put $5,000 into her IRA at age of 25. She will continue to invest the same amount for the next 6 years and then stop contributing. Assume 10% annual return.
How much money will Sharon have in her IRA after 6 years?

A) $30,000
B) $35,575
C) $38,578
D) $41,451

Question 66

Suppose you are a high tax bracket individual and you want to shelter your investment income.The best choice of investment for you to minimize the tax bill is to invest in _________.

A) a bond portfolio
B) stocks with high dividend yields
C) a municipal bond portfolio
D) stocks with low or zero dividend yields

Question 67

An investor can earn a 6% nominal rate of return but inflation is expected to be 3%.If the individual invests $2,000 per year for 20 years the real future value of their investment is ________.(All investments occur at year end).

A) $73,571
B) $66,334
C) $53,251
D) $48,732

Question 68

An investor in the 34% tax bracket would be indifferent between a corporate bond with a before tax yield of 8% and a municipal bond with a yield of _________.

A) 3.91%
B) 6.15%
C) 5.28%
D) 10.72%

Question 69

An individual wants to have $95,000 per year to live on when they retire in 30 years.The individual is planning on living for 20 years after retirement.If the investor can earn 6% during her retirement years and 10% during her working years,how much should she be saving during her working life? (Hint: Treat all calculations as annuities.)

A) $9,872
B) $8,234
C) $7,908
D) $6,624

Question 70

An investor who is in the 35% federal tax bracket and the 5% state bracket buys a 6.5% yield corporate bond.What is his after tax yield?

A) 3.90%
B) 4.75%
C) 6.50%
D) 9.90%

Question 71

Currently,the maximum combined taxable income of a retired household that avoids having to pay any taxes on a portion of their Social Security benefit is ______.

A) $15,000
B) $32,000
C) $45,000
D) $75,000

Question 72

Sharon decides to put $5,000 into her IRA at age of 25. She will continue to invest the same amount for the next 6 years and then stop contributing. Assume 10% annual return.
How much money will Sharon have in her IRA when she is ready to retire at age of 62?

A) $554,856
B) $623,245
C) $738,578
D) $814,527

Question 73

You want to minimize your current tax bill by maximizing your contributions to your _____________.

A) taxable bond portfolio
B) Roth IRA
C) 401k or 403b plan
D) taxable savings account