Question

C. GrabBag

9. Eriko earns $45,755 per year. She contributes 8% of her income to her 401(k) plan at work. In her tax bracket, she would pay 37% of her income in state and federal income taxes. a. How much is she saving this year on her taxes by making these 401(k) plan contributions? b. Suppose that instead of contributing to her 401(k) plan, she decides instead to deposit the same amount of money to a Roth IRA. What would her tax savings be this year if the money went into the Roth instead? c. Eriko has projected that her retirement account deposits will have grown to $318,902 by the time she retires. Assuming the same 37% tax rate, what would the after-tax value of her account be if the money is in a 401(k)? In a Roth IRA? d. Suppose that Eriko’s company offers a 75% match up to 10% of salary, how would this affect her decision of whether to stick with the 401(k) or instead switch to a Roth IRA?

Answer 1

Yearly income is $45,755

Tax rate = 37%

Contribution = 8% of $45,755 = $3,660.4

(a)

401(k) plan contributions are deductible for tax purpose in the year of making contribution.

So tax savings as a result of 401(k) contribution

= $3,660.4 x 37%

= $1,354.348

(b)

Contribution made to Roth IRA are not deductible in the year of making contribution as it is deemed they ra making contribution from after tax income.

So no Tax saving in the year of contribution

(c)

Deposit amount at the time of retirement = $318,902

1. 401(k) contribution - at the time of withdrawal entire amount is taxable

So after tax earnings = $318,902 ( 1-37%)

= $200,908.26

2. Roth IRA - the entire amount will be tax free at the time of withdrawal

So after tax earnings = $318,902

(d)

Employers match Contribution = $45,755 x 8% x 75%

= $2,745.3

The employer's contribution will be taken as 401(k) contribution not regarding the method of contribution of employee is treated. That is even if the employee contribution is treated as per 401(k) contribution or Roth IRA, the employers contribution will be treated as 401(k) contribution. So this will not affect the decision of the employee to change between 401(k) contribution and Roth IRA.