Suppose you have $50,000 in your 401k/IRA retirement account and will not withdr

Question

Suppose you have $50,000 in your 401k/IRA retirement account and will not withdraw any time soon because of the 10% withdrawal penalty. For more on 401k and IRA,

http://www.investopedia.com/terms/1/401kplan.asp

http://www.investopedia.com/terms/i/ira.asp

Q1. What are the benefits of 401k/IRA accounts over regular taxable accounts?

Q2. How will “you” allocate $50k between stocks and bonds? Justify your decision.

Note: There’s no optimal magical allocation for everyone because it’s subject to your individual situation/goal. Explain why your allocation is best for you.

Q3. If the market interest rate increases, is it a good news to the bond investors? Explain.

Q4. If Federal Reserve increases the Fed Funds rate, will the long-term interest rate always increase?

Explanation / Answer

An IRA is simply an account that you can shelter your retirement in to help you save on taxes. It’s super easy to open an IRA. You just need taxable income and to complete a little paperwork. You can open up an IRA at most banks or investment firms.

1.In 401k/IRA retirement account earnings accrue tax deferred basis as compared to taxable amount where earnings are taxed.Money is contributed to 401k on a tax free basis while the money on taxable account is taxed and the earnings are also taxed so that you need to pay tax before earnings materialize while in 401k the earnings gets accumulated tax free and are taxed at the time of withdrawal has a advantage of tax defferal.Tax drag is present when Tax savings in 401k is much larger than regular taxable account. You can get money from 401k/IRA account anytime and for whatever purpose without any restrictions as compared to taxable account which has restrictions on time and purpose of withdrawl.Depending on whether deferring of taxes is valuable that is you shall going to fall in larger tax bracket than investing in taxable account is more preferable while if you think you shall going to fall in lesser tax bracket than investing in 401k/IRA account is more sensible because most of the income in 401k is taxed at time of withdrawal only.

The largest amount you can contribute to your traditional IRA in a year is $5,000. It’s much less than what you can contribute to a 401(k), but if you don’t have access to a 401(k) plan, it’s better than nothing. Remember, you can deduct that $5,000 from your taxable income at tax time. Also, this is $5,000 TOTAL. If you have more than one IRA, the limit applies to the total contributions made to all of your traditional IRAs. When you’re 50 years old or older, you’re allowed to save an additional $1,000 a year to catch up your savings as you prepare for retirement. If you contribute more than $5,000 a year, you’ll be hit with a 6% penalty on the amount you went over. So keep track of how much you’re investing!

Ability to deduct the full $5,000 contribution depends on a few factors. It would be nice if the IRS made it simple and always allowed you to deduct the full $5,000 you contribute to your IRA from your taxable income, but we know the IRS doesn’t like to make things easy. Consequently, we have a bunch of rules that muddle things up.

Two factors that determine whether you’re eligible to deduct the full $5,000 from you taxable income are 1) your adjusted gross income and 2) whether you have access to an employer-sponsored retirement account.

3.If the market interest rate increases, is it not good news to the bond investors since the value of bond decreases.

4q.The federal funds rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. The rate may vary from depository institution to depository institution and from day to day. The Federal Reserve Act specifies that the FOMC should seek "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." At each meeting, the FOMC closely examines a number of indicators of current and prospective economic developments. Then, cognizant that its actions affect economic activity with a lag, it must decide whether to alter the federal funds rate. A decrease in the federal funds interest rate stimulates economic growth, but an excessively high level of economic activity can cause inflation pressures to build to a point that ultimately undermines the sustainability of an economic expansion. An increase in the federal funds interest rate will curb economic growth and help contain inflation pressures, and thus can promote the sustainability of an economic expansion, but too large an increase could retard economic growth too much. The Committee's actions on interest rates are undertaken to achieve the maximum rate of economic growth consistent with price stability and moderate long-term interest rates.

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