Question

In: Accounting

Jenny (35 years old) is considering making a one-time contribution to either a traditional 401(k) plan...

Jenny (35 years old) is considering making a one-time contribution to either a traditional 401(k) plan or to a Roth 401(k) plan. She plans to withdraw the account balance when she retires in 40 years. Jenny expects to earn a 7 percent before-tax rate of return no matter which plan she contributes to. Which of the following statements is true?

Multiple Choice

  • If Jenny's marginal tax rate in the year of contribution is higher than her marginal tax rate in the year of distribution, she will earn a higher after-tax rate of return on the traditional 401(k) plan than on the Roth 401(k) plan.

  • If Jenny's marginal tax rate in the year of contribution is lower than her marginal tax rate in the year of distribution, she will earn a higher after-tax rate of return on the traditional 401(k) plan than on the Roth 401(k) plan.

  • Jenny will earn the same after-tax rate of return no matter which plan she contributes to.

  • Jenny is not allowed to make a one-time contribution to either plan.

Solutions

Expert Solution

Correct answer is option A. If Jenny's marginal tax rate in the year of contribution is higher than her marginal tax rate in the year of distribution, she will earn a higher after-tax rate of return on the traditional 401(k) plan than on the Roth 401(k) plan.

Rate of Return from traditional 401(k) and Roth 401(k) plans are depended on the basis of the tax rate in the year of contribution and distribution. If marginal tax rate of contribution is higher than in the year of distribution, we will earn higher after tax rate of return from traditional 401(k).

Option B is incorrect because if marginal tax rate in the year of contribution is lower than her marginal tax rate in the year of distribution, she will earn a lower after-tax rate of return on the traditional 401(k) plan than on the Roth 401(k). And it is wrongly stated as we will earn higher after-tax rate of return.

Option c is incorrect. Because it stated as jenny will earn the same after tax rate of return no matter which plan she contributes to.But the after tax rate of return vary accaording to the plan in which she contributes.

Option D is incorrect as it shows jenny is not allowed to make a one-time contribution to either plan. But it is false because she is allowed to make a one-time contribution to either plan.

Therefore, option A is true.

ekkarill92 answered 1 year ago
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