-You deposit 5% of your $40,000 annual income in a 401(K) plan at the end of eac
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Question
-You deposit 5% of your $40,000 annual income in a 401(K) plan at the end of each year. Your employer matches 2% of your earnings. You expect the plan to earn 10% and you are in the 25% tax bracket.
A. What is your annual investment?
B. What is your one year returnon the plan?
-Assuming the employee actual annual investment is $3,000/year (including the employer’s contribution) , his tax rate stays at 25%, and the 401(k) yield remains at 10% over a 20-year career, when the employee retires the 401(k) will be worth:
-Now assume you just retired, and have accumulated $170,000 in the 401K. If you continue to earn 10% and want to withdraw $20,000 at the beginning of each year, how many years can you do this?
Explanation / Answer
Part 1.
A. My Annual investment = 5% of $40,000 + contribution from employer (2% of $40,000)
= 7% of $40,000
= $2,800
B. One Year return on the plan = 10% of investment
= 10% of $2,800
= $280
Also note that this interest is not taxed, unless you withdraw the money.
Part 2.
Given annual investment (PMT) = $3,000
Interest Rate (I/Y) = 10%
No of Years (N) = 20
Present Value (PV) = 0
Note that investment is made at the end of each year.
Using financial calculator, feeding the value and calculating FV
FV= $171,825
Part 3.
Given present value (PV) = $170,000
Interest Rate (I/Y) = 10%
PMT = -$20,000
Future Value = 0
Note that money is withdrawn at the beginning of each year
Change the mode of financial calculator to BGN mode
Using Financial Calculator, feeding these values and solving for N i.e. no of years, we get
N = 16
Also note that in 16th year, balance at the beginning of the year would be $11,137 and employee would not be able to withdraw $20,000.
In other words he can withdraw $20,000 at the beginning of each year for 15 years.
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