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

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

Answer 2

B

Question 3

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

Answer 3

A

Question 4

If you want 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 5

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 6

Tax shelters ________.

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

Question 7

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

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

Question 8

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

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

Question 9

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 10

You earn 6% on your corporate bond portfolio this year, and you are in a 24% federal tax bracket and an 9% state tax bracket. Your after-tax return is ________. (Assume that federal taxes are not deductible against state taxes and vice versa).

A) 4.5%
B) 4.14%
C) 4.02%
D) 3.12%

Question 11

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 nor worse off
D) make you either better or worse off depending on your age

Question 12

The calculation of a standard annuity, using the PMY function of Excel or a financial calculator, will produce an insufficient income because that approach fails to consider ________.

A) variable interest rates
B) retiree income needs
C) market volatility
D) inflation

Question 13

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 14

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 15

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 16

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.

Question 17

Contributions to a ________ are not tax deductible.

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

Question 18

The use of a Roth IRA versus a traditional IRA will allow you to ________.

A) retire with less money in your savings account
B) select more sophisticated investments
C) avoid relying as much upon social security
D) protect your spouse from a decline in income upon death

Question 19

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 20

The tax effect of a traditional retirement plan is to ________ taxes.

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

Question 21

Employers commonly match at least some portion of employee contributions to:
I) 401k plans
II) 403b plans
III) Self-directed retirement plans

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

Question 22

Withdrawals from a traditional retirement plan prior to age ________ are taxable and must pay a ________ tax penalty.

A) 59½; 10%
B) 62; 5%
C) 65; 7½ %
D) 63½; 5%

Question 23

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

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

Question 24

Contributions to a traditional retirement plan are ________, and contributions to a Roth retirement plan are ________.

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

Question 25

One feasible 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 26

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 want to retire early

Question 27

A tax shelter that allows for tax-exempt saving for higher education is called a ________.

A) Roth savings plan
B) 403b
C) 401k
D) 529 plan

Question 28

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 29

An investor may deposit $2,000 into a traditional or Roth IRA. After 30 years, given a 9% annual return and a 20% tax rate, how much more or less money will the investor have if all investments are liquidated after 30 years?

A) Roth value is $5,307 higher
B) Roth value is $4,907 higher
C) traditional value is $4,907 higher
D) traditional value is $5,307 higher

Question 30

Under current rules most workers will have ________ of their salary deducted to pay for Social Security retirement benefits and ________ toward Medicare.

A) 1.45%; 6.2%
B) 6.2%; 1.45%
C) 7.65%; 1.45%%
D) 15.3%; 4.9%

Question 31

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 32

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 33

In 2018, 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) $128,400; $0
D) $96,000; $10,000

Question 34

The practice of trying to buy life insurance upon diagnosis of a terminal illness is an example of ________.

A) estate planning
B) profit maximization
C) adverse selection
D) insurance fraud

Question 35

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) 6.8%
B) 3.69%
C) 4.91%
D) 4.25%

Question 36

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 37

In planning for retirement, an investor decides she will save $15,000 every year for 45 years. At a 10% return on her investment, how much money will she have at the end of 45 years (to the nearest hundred thousand dollars)?

A) $1,400,000
B) $2,800,000
C) $4,900,000
D) $10,800,000

Question 38

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

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

Question 39

A retirement plan that offers a tax shelter will defer ________ taxes on contributions and investment earnings.

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

Question 40

An investor wants to retire when she has $3,000,000 in savings, after-taxes. Given a 20% tax rate at retirement, how much money, per year, must she save in order to retire in 30 years, given an 11% annual return? Assume she uses a traditional IRA and liquidates the entire portfolio at retirement.

A) $12,827
B) $13,903
C) $15,074
D) $18,842

Question 41

A regular retirement plan requires that taxes be paid at the time the money is removed from the plan. What is the after-tax value of a $6000 deposit into a retirement plan today that generates an 7% return for 20 years if the investor is taxed at the 24% level?

A) $17,646
B) $20,135
C) $21,685
D) $23,305

Question 42

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 43

The employees of a firm complain that they cannot afford to contribute $9,000 per year to a 401k because of the loss of $9,000 of take-home pay. In fact, how much will the take-home pay be reduced if all taxes combined total 33%?

A) $6,030
B) $6,340
C) $7,637
D) $8,000

Question 44

An investor has an effective tax rate on all items of 33%, and he decides to put $9,000 into a 401k. 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) $29,886

Question 45

Withdrawals after retirement from a traditional retirement plan are ________, and withdrawals after retirement from a Roth retirement plan are ________.

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

Question 46

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

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

Question 47

An insurance company plans to sell annuities to investors. Based on actuarial calculations, an investor has a 30-year life span, and she wants a $70,000-per-year annuity, payable at the end of each year. If the insurance company uses a 3.3% assumed investment rate, how much should the annuity cost?

A) $696,928
B) $743,874
C) $833,552
D) $1,320,319

Question 48

A bond portfolio and a stock portfolio both provided an 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

A worker plans to retire in 32 years. He hopes to receive $68,000 per year in retirement income. If inflation is forecast at 3.1% per year, what annual income should he plan to receive in the first year of retirement in order to maintain the purchasing power on $68,000?

A) $68,000
B) $76,159
C) $98,398
D) $180,628

Question 50

An insurance company plans to sell annuities to investors. Based on actuarial calculations, an investor has a 18-year life span, and he wants a $40,000-per-year annuity, payable at the end of each year. If the insurance company uses a 3.78% assumed investment rate, how much should the annuity cost?

A) $496,928
B) $512,236
C) $515,548
D) $553.982

Question 51

In planning for retirement, an investor decides she will save $17,000 every year for 38 years. At an 8% return on her investment, how much money will she have at the end of 38 years (to the nearest hundred thousand dollars)?

A) $3,700,000
B) $6,800,000
C) $7,900,000
D) $10,800,000

Question 52

What is the value of a $3,500 deposit into a retirement plan if the investment earns 10.5% per year for 20 years?

A) $12,174
B) $25,782
C) $14,652
D) $15,523

Question 53

A worker plans to retire in 22 years. He needs $27,000 per year in retirement income in today's dollars. If inflation is forecast at 3.1% per year, what annual income should he plan to receive in the first year of retirement in order to maintain the purchasing power on $27,000?

A) $30,353
B) $54,159
C) $37,398
D) $52,851

Question 54

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

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

Question 55

In planning for retirement, an investor decides she will save $3,000 every year for 25 years. At a 5.7% return on her investment, how much money will she have at the end of 25 years?

A) $119,015
B) $125,316
C) $157,805
D) $128,420

Question 56

An insurance company plans to sell annuities to investors. Based on actuarial calculations, an investor has a 15-year life span, and he wants 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 57

An investor must decide between putting a one-time contribution of $2000 into a regular retirement plan or putting $1,440 into a Roth retirement plan. 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 retirement plan
B) the investment in the Roth retirement plan
C) both investments will have the same future value after-taxes
D) the answer cannot be determined from the information given

Question 58

An investor plans to retire at age 62 with total savings of $1,000,000. If she is currently 37 years old, has no savings, and expects to earn 9% per year on her investments, how much money must she set aside every year?

A) $15,546
B) $11,806
C) $12,892
D) $10,324

Question 59

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

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

Question 60

An employee uses her firm's 401k plan. If she decides to contribute $ $12,000 per year and pays an effective tax rate for all items of 24%, how much will she actually take home after the reduction?

A) $3,080
B) $4,210
C) $9,120
D) $11,000

Question 61

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

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

Question 62

An investor in a 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 63

In planning for retirement, an investor decides she will save $4,000 every year for 35 years. At a 6.8% return on her investment, how much money will she have at the end of 35 years?

A) $519,015
B) $525,316
C) $529,403
D) $628,420

Question 64

A nonprofit organization offers a 5.5% salary contribution to John's 403b plan regardless of his own contributions, plus a matching 5.5% when John contributes 5.5% of his salary. John makes $.66,000 a year.
What is the amount of the total contribution to his 403b if John contributes 5.5% of his own money?

A) $7,260
B) $10,890
C) $11,200
D) $12,500

Question 65

Sharon decides to put $6,500 into her retirement plan at the age of 26. She will continue to invest the same amount for a total of 6 years and then stop contributing. Assume 10.8% annual return.
How much money will Sharon have in her retirement plan after 6 years?

A) $30,000
B) $35,575
C) $38,175
D) $61,451

Question 66

An investor can earn a 6.7% nominal rate of return, but inflation is expected to be 3%. If the individual invests $3,000 per year for 25 years, the real future value of this investment is ________. (All investments occur at year-end).

A) $73,571
B) $66,334
C) $118,293
D) $48,732

Question 67

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 68

An investor who is in a 35% federal tax bracket and a 5% state bracket buys a 6.5% yield corporate bond. What is his after-tax yield? (Assume that federal taxes are not deductible against state taxes and vice versa).

A) 3.9%
B) 4.75%
C) 6.5%
D) 9.9%

Question 69

An individual wants to have $57,000 per year to live on when she retires in 27 years. The individual is planning on living for 23 years after retirement. If the investor can earn 6.2% during her retirement years and 9.10% during her working years, how much should she be saving during her working life? (Hint: Treat all calculations as annuities.)

A) $29,872
B) $28,234
C) $17,908
D) $26,317

Question 70

Sharon decides to put $6,500 into her retirement plan at the age of 26. She will continue to invest the same amount for a total of 6 years and then stop contributing. Assume 10.8% annual return.
How much money will Sharon have in her retirement plan when she is ready to retire at age 63?

A) $554,856
B) $623,245
C) $1,229,675
D) $1,311,805

Question 71

Shawn decides to put $5,000 into his retirement plan at the age of 22. He will continue to invest the same amount for a total of 16 years and then stop contributing. Assume 10% annual return.
How much money will Shawn who will be 38 years old at that point, have in his retirement plan when he is ready to retire at age 62? Assume the same 10% annual return.

A) $554,856
B) $623,245
C) $1,770,476
D) $1,311,805

Question 72

A nonprofit organization offers a 5% salary contribution to John's 403b plan regardless of his own contributions, plus a matching 5% when John contributes 5% of his salary. John makes $56,000 a year. He is in the 24% tax bracket.
What is John's total cost of his 5% contribution net of taxes?

A) $2,128
B) $2,800
C) $784
D) $3,500

Question 73

A nonprofit organization offers a 5.5% salary contribution to John's 403b plan regardless of his own contributions, plus a matching 5.5% when John contributes 5.5% of his salary. John makes $66,000 a year.
What is John's effective salary reduction if he is in the 24% tax bracket?

A) $2,758
B) $2,800
C) $3,600
D) $5,400

Question 74

If you plan for a bequest for your children, your grandchildren, their children, and so on, your planning horizon becomes ________.

A) equal to the life span of your children
B) 100 years, or your lifetime, whichever ends first
C) infinite
D) double what it would have been without the bequest