Q1. Jane Doe is considering job offers from ABC and XYZ companies. Jane is 45 years old. ABC sponsors a profit sharing plan and XYZ sponsors a 401(k) plan. Jane wants to figure out which company has the better plan for her. Details for the plans are listed below.
ABC Company - Employees are eligible after one year of service. The company contributes 3% of pay to each participant's account plus an additional amount based on company performance. The average additional amount each year for the past 15 years has been 4% of pay.
XYZ Company - Employees are eligible to participate immediately. Employees can contribute up to 15% of pay to the plan. XYZ will match all contributions up to 5% of pay.
a. Project Jane's account balance to age 65 under both company plans. What assumptions do you need to make about Jane's future?
b. In your opinion, which plan is better for Jane? Provide your rationale.
Q2. Jane and John Doe are twins. Jane saves $10,000 per year from age 25 to 34 and nothing from age 35 onward (10 years of saving in total). John saves nothing from age 25 to 34 and $10,000 from age 35 to 64 (30 years of saving it total).
a. Assume that Jane and John both earn 6.5% annual investment income. Who has more money at age 65?
b. How does your answer change if annual investment income is 5% or 7.5%?
Q3. Susan Doe is retiring next month. She has $400,000 in her 401(k) plan account. Assume that Susan can earn 5% annually and that she withdraws money at the beginning of each year.
a. How much can Susan withdraw every year so that the savings will last 25 years? Show your work.
b. Susan really wants to visit Europe. Assume that Susan spends $15,000 of her savings in the first month of retirement for a trip. How does this change your answer in a?
c. Assume that at year 10, Susan's investments lose 10% of their value rather than earning 5%. Recalculate her withdrawal amount so that the money lasts the remainder of the 25 year period.
Q4. George Doe, age 55, is thinking about contributing on a post-tax basis to his employer's 401(k) plan (i.e., Roth 401(k)) rather than on a pre-tax basis. Assume the following facts:
-George's pre-tax salary = $100,000 and does not change
-George's income tax rate is 30%
-Investment income is taxed at 20%
-George will contribute 5% of his salary to the 401(k) plan
-George will save an additional 5% of his post-tax salary outside the plan in taxable accounts
-Annual investment income = 5%
-Taxes, contributions and investment income occur at the end of the year
-Roth 401(k) taxation: Investment earnings on post-tax contributions are distributed tax-free
-Regular 401(k) taxation: All distributions are taxed as income
a. Compare the total amount saved over the next 10 years on a pre-tax and post-tax 401(k) contribution basis. Keep in mind that the total amount is the sum of the 401(k) and outside savings. Investment income on outside savings is taxable every year.
b. If tax rates in 10 years are unchanged, which savings strategy is likely to produce better retirement income opportunity? Provide your rationale.
c. How does your answer in b change if the tax rates increase or decrease?