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Indiv. 2008 TB Ch 18 - Chapter I:18 Taxes and Investment...

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Chapter I:18 Taxes and Investment Planning True-False I:18-1. In the Current Model, investment earnings are taxed currently. T, p. I:18-2. I:18-2. In the Deferred Model, investment earnings are taxed at the end of the investment period. T, p. I:18-2. I:18-3. In the Exempt Model, the earnings are never taxed. T, p. I:18-2. I:18-4. In the Pension Model, the initial investment is deductible or excludable from gross income, and investment earnings are taxed currently. F, p. I:18-2. Solution: The initial investment is deductible or excludable from gross income, and investment earnings are taxed at the end of the investment period. I:18-5. Savings accounts and money market funds are examples of investments taxed under the Current Model. T, p. I:18-3. I:18-6. A single taxpayer earns a salary of $6,000. If he is in the 10% marginal tax bracket, he has $5,400 of after-tax dollars available to invest. T, p. I:18-3; Example I:18-2. Solution: $6,000 (1.00 - .10) = $5,400. I:18-7. A taxpayer in the 25% marginal tax bracket invests $1,000 at 10% interest before taxes. At the end of year one, the taxpayer will have accumulated after-tax dollars of $1,075. T, p. I:18-4; Example I:18-3. Solution: $1,000 + 1,000(.1)(.75) = $1,075. I:18-8. Investments conforming to the Current Model provide no deferral advantages because earnings are taxed currently. T, p. I:18-4. I:18-9. The nondeductible traditional IRA is a classic example of the Pension Model. F, p. I:18- 5. Solution: It is an example of the Deferred Model. I:TB18-1
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I:18-10. In the Deferred Model, only after-tax dollars are invested. T, p. I:18-5. I:18-11. The Deferred Model investment outperforms the Current Model investment if interest rates and tax rates are constant over time because the interest on the Deferred Model investment grows tax free until withdrawal. T, p. I:18-7. I:18-12. One of the characteristics of the Exempt Model is that earnings on the investment are exempt from explicit taxation. T, p. I:18-10. I:18-13. One characteristic of the Exempt Model is the fact that, like the Current and Deferred Models, only after-tax dollars are invested. T, p. I:18-10. I:18-14. One characteristic of the Pension Model is the fact that, like the Current and Deferred Models, only after-tax dollars are invested. F, p. I:18-10. Solution: Before-tax dollars are invested. I:18-15. Examples of the Exempt Model include deductible IRAs, H.R. 10 plans, Sec. 401(k) plans, and tax deferred annuities. F, p. I:18-11. Solution: These are examples of the Pension Model. I:18-16. Under the Pension Model, the entire accumulation, not just the earnings, is taxed at the end of the investment horizon. T, p. I:18-11. I:18-17. The Deferred Model offers two levels of tax deferral—the original contribution escapes current taxation as do the earnings on the underlying investment. F, p. I:18-11. Solution: This describes the Pension Model. In the Deferred Model, only taxes on investment earnings are deferred.
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