Congratulations! Today is your 20 th birthday (July 1 st , 2018), but you are br
ID: 2620251 • Letter: C
Question
Congratulations! Today is your 20th birthday (July 1st, 2018), but you are broke. You just started working full-time, earning a taxable income of $100,000 per year. Your goal is to have $1 billion by your 85th birthday (i.e., 65 years from today). Your employer offers a 401(k) plan, and within that plan you choose to invest in an extreme low-cost S&P 600 small cap index mutual fund (like ones offered by Fidelity, Vanguard, etc.). Assume the long-term expected return on the S&P 600 small cap index mutual fund is 12.7% per year. Your employer pays you at the end of each month, with the first paycheck expected July 31st. 401(k) plan contributions are tax deductible. Your marginal tax rate is If the employer offers a match, it will be dollar for dollar up to 10% of your salary. Your CPA provided you with the following federal and state tax rate tables - assume you are and plan to stay single.
Federal - Single filers
Tax rate Taxable income bracket Tax owed
10% $0 to $9,525 10% of taxable income
12% $9,526 to $38,700 $952.50 plus 12% of the amount over $9,525
22% $38,701 to $82,500 $4,453.50 plus 22% of the amount over $38,700
24% $82,501 to $157,500 $14,089.50 plus 24% of the amount over $82,500
32% $157,501 to $200,000 $32,089.50 plus 32% of the amount over $157,500
35% $200,001 to $500,000 $45,689.50 plus 35% of the amount over $200,000
Explanation / Answer
In the given scenario, we need to calculate the monthly deposits required to accumulate the target fund. For this computation, we will use the formula to calculate Future Value of Annuity.
Formula: FV of ordinary annuity = P*{[(1+r)n-1]/r}
Where, FV of ordinary annuity = $1,000,000,000 (Target amount)
P = Monthly deposits required to accumulate the target amount
r = Rate of return per period = 12.7% / 12 = 1.05833% or 0.010583333
n = Number of periods = 12*65 = 780 months
Computation:
$1,000,000,000 = P*{[(1 + 0.01058333)780-1]/0.01058333}
$1,000,000,000 = P*[3681.568664 / 0.01058333]
P = $1,000,000,000 / [3681.568664 / 0.01058333] = $2,874.68
So, you would need to make a deposit of$2,874.68 per month to accumulate $1,000,000,000 by your 85th birthday.
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