Chap021 - Chapter 21 - Taxes, Inflation, and Investment...

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Chapter 21 - Taxes, Inflation, and Investment Strategy CHAPTER 21 TAXES, INFLATION, AND INVESTMENT STRATEGY 1. Moral hazard. The owner now has an incentive to cause a loss and file a claim. 2. The owner will suffer from adverse selection. The owner will attract cargo that would normally cost more than the flat fee being charged. 3. Passive investors who are not sophisticated and looking for reduced fees. These investors are unable to frequently review their portfolio and reallocate the investment assets. The target date fund does this automatically for the investor. 4. The social security annuity is paid out for the balance of your life, regardless of how long you live. The amount is determined based on the calculation of a Primary Insurance Amount (PIA). This determines the monthly annuity paid. Like insurance, once the worker works the minimum number of years, the policy is fully paid and the recipient is guaranteed an income when reaching the designated age. There are other components of SS that are pure insurance such as survivorship benefits that are paid upon the death of a SS recipient to beneficiaries designated by law. 5. The progressive tax code sharpens the importance of taxes during the retirement years. High tax rates during retirement reduce the effectiveness of a tax shelter. In the case of social security, the progressive tax code allocates a relatively larger share of retirement benefits to low-income individuals. Additionally, the lower tax brackets of a progressive system, during the retirement, years allows you to pay lower taxes over time, significantly increasing retirement consumption. The use of an IRA-style tax shelter increases the retirement annuity, thus an improvement over what you obtain from a tax shelter with the flat tax. 6. With a savings rate of 16%, the retirement annuity would be $205,060 (compared to $192,244 with the 15% savings rate). Spreadsheet 21.1: Adjusted for Change in Savings Rate 21-1
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Chapter 21 - Taxes, Inflation, and Investment Strategy 7. With a savings rate of 16%, the retirement annuity will be $52,979 (vs. $49,668). The growth in the real retirement annuity (6.67%) is the same as with the case of no inflation. Spreadsheet 21.2: Adjusted for Change in Savings Rate 8. The objective is to obtain a real retirement annuity of $49,668, as in Spreadsheet 21.2. In Spreadsheet 21.3: Backloading the Real Savings Plan, add cell F42 for the desired annuity and cell F43 for the difference between the annuity with savings from real income and the desired annuity in cell F42. Select Tools/Goal Seek from the menu bar. Set up the following parameters: Set Cell: F43 To Value: 0 By Changing Cell: D2 21-2
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Chapter 21 - Taxes, Inflation, and Investment Strategy Spreadsheet 21.3: With Target Cell for Desired Real Annuity 21-3
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Chapter 21 - Taxes, Inflation, and Investment Strategy We find that a savings rate of 8.3% (C2) from real income yields the desired real retirement annuity, as the modified spreadsheet on the next page shows:
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Chap021 - Chapter 21 - Taxes, Inflation, and Investment...

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