4. (a) Studebaker is eligible to put 12,000 before-tax dollars each year into a

Question

4. (a) Studebaker is eligible to put 12,000 before-tax dollars each year into a tax-deferred annuity (TDA). In order to invest in a TDA, however, he must have his salary reduced, and the case indicates that he can afford a reduction in his spendable income of $3,052 each year without disrupting his lifestyle. One investment option is to increase the amount placed into a TDA each year to the legal maximum of $12,000 and move funds from the money market to cover the resulting shortfall in Studebaker's spendable income. How much money will he need to transfer each year from the money market?
Limit of investment $12,000 Minus spendable income $3,052 Transfer money to money market $8,948
b) Assume Studebaker will earn a 4 percent after-tax annual return in the money market investing $30,000. For how many years can he contribute the maximum amount to the TDA and cover any shortfall in his spendable income with funds from the money market? (Round your answer to the next highest year)

Before doing the analysis Comer decides that it is quite reasonable to assume that (1) any money placed in the SPA will earn 7 percent over the 20-year time hori- zon; (2) Northern Annuities (a TDA option) will also pay 7 percent; and (3) Modern Investments, the other TDA option, will pay 8 percent for the first 10 years (the guaranteed time) and 5 percent for the last 10. Under these conditions Comer would assume that any money placed with Modern Investments would grow at 8 percent during years 1 to 10 and 5 percent in years 11 to 15. Studebaker would then have reached age 55 and could move these funds without penalty to Northern Annuities. Thus, Studebaker's money would earn 7 percent during years 16 to 20.

Explanation / Answer

Maximum limit of investment

= $12,000

Amount of money that can be safely invested

= $3,052

Amount of money need to be transferred from money market each year(12000-3052

= $8,948

Maximum limit of investment

= $12,000

Amount of money that can be safely invested

= $3,052

Amount of money need to be transferred from money market each year(12000-3052

= $8,948

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