Imagine you have two employment opportunities with slightly different retirement

Question

Imagine you have two employment opportunities with slightly different retirement plans. The first opportunity is an employer that will double your plan contributions up to $5,000 per year, and the second opportunity is an employer that will double your plan contributions up to $6,500 per year. Regardless of your employer, you will maximize contributions to get all the employer match, and invest in a balance fund (stock and bond) expected to earn 7% per year. What is the expected value of the extra employer contribution from the second employer after 40 years? Explain how an extra $1,500 in annual salary from the first employer would not make the two employement offers financially identical. [Hint: consider taxes]

Explanation / Answer

a.) Expected Value of Additional Employer Contribution after 40 years

= 1500 x {((1+0.07)40-1)/0.07}

= 1500 x 199.63

= 299,453

b.) In case an employee under first offer is offer an additional salary worth $1500/year, savings he will be able to make will be on the amount invested post deduction of taxes.

Let tax rate be 35%

Actual amount invested annually =1500x(1-0.35) =$975

Future Value of this savings = 975 x {((1+0.07)40-1)/0.07}

                                         = 975 x 199.63

                                         = 194,644

Though the taxes will also be levied on the withdrawals from the contribution account amount in part-(a) but usually the income falls post retirement and hence they will likely be subjected to lower income tax rates.

Thus, the offer from first employer is not financially identical to the one offered by second employer.

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