An employee contributes 9% of his salary to his 401(k) plan and the employer matches with 40% of the first 6% of the employee's salary. The employee earns $90,000 and is in a 28% tax bracket. If the employee earns 10% on the plan investments, what is his one-year rate of return relative to the net amount of money he invested?

Question

Quizplus · Accepted Answer

The one-year rate of return is calculated as the ratio of the ending value to the beginning value minus one. The ending value of the employee's investment is the sum of his own contribution ($5,832) and the employer contribution ($11,286) which equals $17,118. The beginning value is just the employee's after-tax contribution ($5,832). Therefore, the HPR is (17,118/5,832) - 1 = 1.9352 or 193.52%. However, the question asks for the rate of return relative to the net amount invested, which is just the employee's after-tax contribution. Therefore, we divide the HPR by the employee's after-tax contribution: 1.9352 / 1 = 1.9352. Finally, we convert this decimal to a percentage: 193.52%.

An Employee Contributes 9% of His Salary to His 401(k)