CH21

Question 1

What is the current U.S. tax rate for interest income?

Answer 1

Same rate as ordinary income

Interest income is taxed at the same rate as regular income according to current U.S. law.

Question 2

What are the tax rates for dividends and long-term capital gains for low- to moderate-income investors?

Answer 2

0%

This rate applies to qualifying low- to moderate-income investors.

Question 3

What is the tax rate for dividends and long-term capital gains for middle- to upper-income investors?

Answer 3

15%

This rate applies to qualifying middle- to upper-income investors.

Question 4

What is the tax rate for dividends and long-term capital gains for highest-income households?

Answer 4

20%

This rate applies to the highest-income households.

Question 5

What is the maximum contribution limit for a 401(k) plan in 2023?

Answer 5

$22,500

Employees may contribute this amount to their 401(k) plans in 2023.

Question 6

What is the additional contribution limit for individuals over age 50 in a 401(k) plan?

Answer 6

$30,000

Individuals over age 50 can contribute an additional amount to their 401(k) plans.

Question 7

What is the annual contribution limit for IRAs?

Answer 7

$6,500

This limit applies to standard IRA contributions.

Question 8

What is the additional contribution for individuals over age 50 to IRAs?

Answer 8

$1,000

This is the additional amount allowed for those over age 50.

Question 9

What penalty is incurred for early withdrawal from an IRA before age 59.5?

Answer 9

10%

This penalty applies to withdrawals made before the age of 59.5.

Question 10

What is the tax treatment of contributions to a Roth IRA?

Answer 10

Not tax-sheltered, but investment earnings are not taxed

Contributions to Roth IRAs are made with after-tax dollars.

Question 11

What is the tax treatment of contributions to a Traditional IRA?

Answer 11

Tax-sheltered until retirement

Contributions to Traditional IRAs are tax-deductible.

Question 12

What are deferred annuities?

Answer 12

Tax-sheltered accounts offered by life insurance companies

Earnings in deferred annuities are tax-free until payout.

Question 13

What factors are considered in developing a retirement plan?

Answer 13

• Time until retirement
• Life expectancy
• Rate of return
• Allocation of income to savings

These factors influence the effectiveness of a retirement plan.

Question 14

How does inflation affect purchasing power?

Answer 14

Inflation erodes purchasing power

Real consumption equals nominal consumption divided by price deflator.

Question 15

What formula is used to calculate real return accounting for inflation?

Answer 15

ROR = (ROR - i) / (1 + i)

Where ROR is nominal return and i is inflation.

Question 16

What is the real rate of return if inflation is 3% and nominal ROR is 6%?

Answer 16

2.91%

Calculated as (.06 - .03) / (1 + .03).

Question 17

What is the price deflator size at age 35 with 3% inflation?

Answer 17

1.16

Calculated as (1 + i)^n with n being 5 years.

Question 18

What is the price deflator size at age 65 with 3% inflation?

Answer 18

2.81

Calculated as (1 + i)^n with n being 35 years.

Question 19

What must investors do to overcome inflation?

Answer 19

• Increase savings
• Achieve higher ROR on investments

Higher returns or savings mitigate inflation’s impact.

Question 20

What is the impact of taxes on retirement benefits?

Answer 20

Taxes reduce retirement benefits available

Overcoming taxes requires larger allocations to savings.

Question 21

What is a flat tax?

Answer 21

Taxes all income above exemption at a fixed rate

Flat taxes can impact retirement savings.

Question 22

What is the purpose of Social Security?

Answer 22

Provide minimum retirement benefits to all workers

Social Security is a federal pension plan.

Question 23

What percentage of income is paid to Social Security?

Answer 23

6.2%

Workers also pay 1.45% toward Medicare.

Question 24

What is the benefit determination period for Social Security?

Answer 24

Top 35 years of earnings and contributions

Only the highest earning years count towards benefits.

Question 25

What happens to Social Security benefits if you retire early (at age 62)?

Answer 25

Reduced amount ## Footnote Benefits are lower if retirement occurs before the full retirement age.

Question 26

What is the largest long-term consumption item?

Answer 26

Dwelling ## Footnote Home ownership represents a significant financial commitment.

Question 27

What is the main risk associated with home ownership?

Answer 27

Largest consumption risk ## Footnote Houses are illiquid investments with transaction costs.

Question 28

What is a safeguard for tough times?

Answer 28

Not trying to buy too much house ## Footnote This implies being cautious about financial commitments during uncertain times.

Question 29

What type of investments are houses considered?

Answer 29

Illiquid investments ## Footnote Illiquid investments are those that cannot be quickly sold or exchanged for cash without a substantial loss in value.

Question 30

What are the transaction costs associated with?

Answer 30

Buying and selling ## Footnote Transaction costs can significantly impact the overall financial outcome of real estate investments.

Question 31

Does the value of a house always increase?

Answer 31

No ## Footnote Value does not always increase, which can lead to financial loss.

Question 32

What is the largest long-term consumption item?

Answer 32

Dwelling ## Footnote A dwelling represents a significant portion of long-term expenses for individuals and families.

Question 33

What is responsible for the largest consumption risk?

Answer 33

Dwelling ## Footnote The financial burden of housing can pose substantial risks to personal finance.

Question 34

What is a life annuity?

Answer 34

An annuity that lasts for your entire life ## Footnote This financial product provides regular payments until the death of the annuitant.

Question 35

Who bears the risk in a life annuity at the time of death?

Answer 35

Provider ## Footnote The provider of the annuity takes on the risk of continuing payments until the annuitant passes away.

Question 36

What is adverse selection?

Answer 36

Tendency for proposed deal to attract the type of party who would make the deal a losing proposition to the offering party ## Footnote This concept is crucial in insurance and finance where risk is unevenly distributed.

Question 37

What is moral hazard?

Answer 37

One party to a contract has an incentive to change behavior to make the contact less attractive to the other party ## Footnote Moral hazard can occur when one party is shielded from risk, leading to risky behavior.