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Question 5: Iris wants to save money to buy a new sailboat. • In 2010, Iris...

Question 5: Iris wants to save money to buy a new sailboat. • In 2010, Iris earns $20,000, and faces a marginal tax rate of 25 percent. • In 2015, Iris will earn $50,000, and face a marginal tax rate of 40 percent. • If she invests money from 2010 to 2015, she will earn interest totaling 50 percent of her initial investment. a. Explain the difference between a registered retirement savings plan (RRSP) and a tax free savings account (TFSA). b. Iris saves $4,000 of her before tax earnings in 2010. If she puts the money into an RRSP, how much can she consume in 2010? If she puts the money into a TFSA? c. How much interest will she earn in the five years from 2010 to 2015? d. In 2015, Iris withdraws the entire amount – principal plus interest – from her savings account. How much tax does she pay on the amount withdrawn from her savings account if it is an RRSP? What if the savings account is a TFSA (how much tax does she pay)? e. Which is the better investment strategy for Iris: putting money into an RRSP or a TFSA? Why?

Expert Solution

Iris wants to save money to buy a new sailboat. • In 2010, Iris earns $20,000, and faces a marginal tax rate of 25 percent. • In 2015, Iris will earn $50,000, and face a marginal tax rate of 40 percent. • If she invests money from 2010 to 2015, she will earn interest totaling 50 percent of her initial investment.

Based on definition, if pre tax saving of iris is $4000, then she can put $4000 in RRSP but

=4000 - 4000* 25%

=4000 - 1000

=3000 in TFSA

b. Iris saves $4,000 of her before tax earnings in 2010. If she puts the money into an RRSP, how much can she consume in 2010? If she puts the money into a TFSA?

: - Iris earning in 2010 is $ 20000

If she puts saving $4000 in RRSP

Consumption = 20000 - 4000

= $16000

If she puts saving $4000 in TFSA

Consumption = 20000 -(16000*25%) - 4000

= 20000 - 4000 - 4000

= 20000 - 8000

= $12000

c. How much interest will she earn in the five years from 2010 to 2015?

: - Total interest during 2010 to 2015 is 50%

She puts a saving $4000 in RRSP

Total interest = 4000 * 50%

= 2000

She puts a saving $4000 in TFSA

Total interest = ( 4000 - 4000*25%) * 50%

= 3000 * 50%

= $1500

d. In 2015, Iris withdraws the entire amount – principal plus interest – from her savings account. How much tax does she pay on the amount withdrawn from her savings account if it is an RRSP? What if the savings account is a TFSA (how much tax does she pay)?

Rahul Sunny answered 8 months ago

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