b Assuming CAP has an 8 after tax rate of return and expects its marginal tax

# B assuming cap has an 8 after tax rate of return and

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b. Assuming CAP has an 8% after-tax rate of return and expects its marginal tax rate to be 35% in five years, how much would it be willing to pay in five years to be indifferent between paying the deferred compensation or paying 15 percent of Tommy’s salary now (ignore payroll taxes)? c. Will Tommy and CAP be able to come to an agreement on deferring Tommy’s salary? d. Assuming that Tommy has an AGI of \$93,000, that Michelle earns \$10,000 working part-time but she does not participate in an employer-sponsored retirement plan, and that they file a joint return, what is the maximum deductible contribution Tommy and Michelle may make to a traditional IRA? e. Tommy has a balance of \$55,000 in his traditional IRA. Due to some recent tax cuts, his marginal tax rate is 20 percent, so he would like to roll his traditional IRA into a Roth IRA. What are the tax consequences to Tommy if he takes \$55,000 out of the IRA, pays the taxes due from the traditional IRA distribution, and contributes the remaining distribution to the Roth IRA? a. Tommy would be indifferent between receiving \$54,000 now or \$74,329 in five years, calculated as follows: Description Amount Explanation (1) Before tax benefit of receiving 15% of salary now (versus receiving deferred payment) \$54,000 \$360,000 × 15% (2) Tax on 15% of salary received now (15,120) (1) × 28% (3) After-tax benefit of receiving 15% of salary now \$38,880 (1) + (2) (4) Future value of after-tax benefit from receiving 15% of salary now. \$52,030 (3) × 1.06 5 To be indifferent between the receiving 15% of his current salary and receiving a deferred compensation payment in five years, Tommy would need to receive a deferred 13-6
Topic 12 - Retirement Savings and Deferred Compensation compensation payment (DC) in five years that would provide him with \$52,030 after- taxes. The amount of the payment is determined by solving for DC in the following equation: \$52,030 = DC × (1 - .30). The deferred compensation payment is \$74,329. b. CAP would be indifferent if it paid Tommy \$54,000 now or \$80,565, calculated as follows: Description Amount Explanation (1) Before-tax cost of paying 15% of Tommy’s salary currently. \$54,000 \$360,000 × 15% (2) Tax benefit from paying 15% of Tommy’s current salary (18,360) (1) × 34% (3) After-tax cost of paying 15% of Tommy’s current salary \$35,640 (1) + (2) (4) Future value cost of paying 15% of Tommy’s current salary \$52,367 (3) × 1.08 5 CAP should be indifferent between paying 15% of Tommy’s salary now or paying deferred compensation to Tommy in five years that costs it \$52,367 after taxes. This amount of deferred compensation (DC) can be determined by solving for DC in the following equation: \$52,367 = DC × (1 - .35). The deferred compensation payment is \$80,565. c. Yes, Tommy would be willing to accept a minimum of \$74,329 and CAP would be willing to pay a maximum of \$80,565. They should be able to come to an agreement because no party will be worse off and at least one party will be better off with a deferred salary in this range.

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• Spring '12
• Bob
• benefit, d. Gerry, a. Alex, e. Tommy

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