Chapter 18

You want to have $1,200,000 when you retire and you are in a defined contribution plan. You can earn 9 percent per year on the money invested and you will retire in 25 years. Your employer also contributes to your plan. The employer will contribute 4 percent of what you put into the plan each year. How much do you have to contribute per year to meet your goal?

$13,622.60 1,200,000/FVIFA (9 percent, 25 years) = $14,167.50 total annual payment required. Your contribution must be 14,167.50/1.04 = $13,622.60 With a financial calculator solve for the payment amount first: FV = 1,200,000, N = 25, I = 9, PV = 0 and solve for PMT to get 14,167.5. The employee's contribution will be 14,167.50/1.04 = $13,622.60

A pension plan has promised to pay out $25 million per year over the next 15 years to its employees. Actuaries estimate the rate of return on the fund's assets will be 5.50 percent. What amount of pension fund reserves (to the nearest dollar) are needed for the plan to be fully funded?

$250,939,524 $25,000,000 × PVIFA (5.50%, 15 yrs.) = $250,939,524 With a Financial Calculator: Input N = 15, I = 5.5, PMT = 25,000,000 and FV = 0 and calculate PV to get 250,939,524

At your new job you estimate that your average salary over your working years will be $95,000 per year. How many more years would you have to work to receive as much benefit from a flat benefit of $3,000 times years of service as you would receive from 3.75 percent of your average salary times years of service?

1.19 times as many years (0.0375 × 95,000)/3,000 = 1.19

Your company sponsors a 401(k) plan into which you deposit 8 percent of your $95,000 annual income. Your company matches 65 percent of the first 10 percent of your earnings. You expect the fund to yield 9 percent next year. If you are currently in the 30 percent tax bracket, what is your one-year return?

182.232%

An employee contributes 9 percent of his salary to his 401(k) plan and the employer matches with 40 percent of the first 6 percent of the employee's salary. The employee earns $90,000 and is in a 28 percent tax bracket. If the employee earns 10 percent on the plan investments, what is his one-year rate of return relative to the net amount of money he invested?

93.52 percent FV1 = 90,000 × (9% + (0.4 × 0.06)) × 1.10 = 11,286; Employee after-tax contribution = 90,000 × (9% × (1 − 28%)) = 5,832; HPR = (11,286/5,832) − 1 = 93.52%

Which of the following is not one of the principal features of ERISA?

Employee termination

If you are married and you and your spouse make $160,000 total per year, you are not allowed to contribute to an IRA.

FALSE

Which of the following statements are true about a traditional IRA? I. Subject to an income limit, in 2016 a single person could contribute up to $5,500 per year ($6,500 if over 50 years old) of pretax income to an IRA. II. All withdrawals are tax-free. III. Earnings on the IRA account are not taxed until withdrawn. IV. You must begin withdrawals at age 59½. V. Withdrawal(s) can be a lump sum or installments.

I, III, and V

A retirement account specifically designed for self-employed persons is a

Keogh.

ERISA established all but which one of the following?

Minimum payouts for defined contribution plans

A Keogh plan is designed for self-employed individuals.

TRUE

Of the different types of defined benefit plans, plans using the final pay method will usually produce the biggest retirement benefit to employees.

TRUE

Pension contributions paid to insured pension funds and the assets purchased with these funds become the legal property of the insurance company and are not the legal property of the individual pension fund contributors.

TRUE

In general, in a defined benefit pension plan, the risk of shortfall is borne by the __________; while in a defined contribution pension plan, the risk of the shortfall is borne by the __________.

employer; employee

A defined benefit pension plan has expected payouts of $15 million per year for eight years and then $20 million per year over the following 15 years. Actuaries have estimated that the fund can be expected to earn an average of 5.25 percent on its assets. The fund currently has reserves of $185,475,000. The plan is ___________ by about ___________ million.

underfunded; $46 185.475m − [15m × PVIFA (5.25%, 8) + 20m × PVIFA (5.25%, 15)/PVIF (5.25%, 8)] = −46.1m With a financial calculator, use the CF functions to solve for the NPV of the fund: Input CF1 to CF8 = 15,000,000 and CF9 to CF23 = 20,000,000, then I = 5.25 and solve for NPV to get 231,534,937. The fund is underfunded by 185,475,000 − 231,534,937 = $46,059,937