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

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.

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

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