Question

In: Finance

Stephen Watkins 4.Stephen plans to retire in twenty years at age sixty seven, at which time...

Stephen Watkins

4.Stephen plans to retire in twenty years at age sixty seven, at which time he will be in the 24 percent marginal income tax bracket. He is considering the purchase of a $200,000 face value whole life policy. The annual premium is $4,000. Alternatively, he is thinking that he could buy a twenty-year $200,000 face value term policy for $500 per year.

a.If he implements a buy term and uses ‘the invest the difference’ strategy, and can earn 8 percent annually in a Roth IRA (assume he saves annually for twenty years), how much will be in his account when the term policy expires?

b.If Stephen were to die at age sixty eight (one year after the term policy expires and he has stopped saving), which strategy (buy the cash value policy or buy the term policy and invest the difference) is the better choice if he continues to save in a Roth IRA?

c.If instead Stephen were to purchase a twenty five-year term policy for $500 per year in premiums, and he were to die at age seventy three (one year after the term policy expires and he has stopped saving), which strategy (buy the cash value policy or buy the term policy and invest the difference) is the better choice if he continues to save in a Roth IRA?

d.Would your answers change if Stephen used a traditional IRA?

Stephen was recently diagnosed with cancer. He underwent treatment and was found to be healthy and cancer free. However, Stephen worries that in the future he might have a reoccurrence, which could affect his chances of obtaining life insurance. If his budget is constrained and he can only afford a twenty-year term policy, what feature(s) or policy rider(s) should he purchase to enable him to continue coverage in the future even if the cancer returns?

this is the entire question

Solutions

Expert Solution

a. Whole life policy worth $200,000 and pemium $4000 for 20 years

Term policy of $200000 and premium of $500 and Invest the difference = $4000 - $500 = $3500 in Roth IRA which a return of 8%, all tax free.

At the end of the term, the investment of difference ($3500) in ROTH IRA can be calculated using the FV function in excel

Here, rate = 8%,

Term or NPER = 20,

PV = 0,

Investments =PMT = - $3500 (Cash outflow)

Type is 1

Thus FV = FV(8%, 20,-3500,0,1) = $172,980.23 (Value of Investment in Roth IRA)

B.

While his policy expires, he wouldnt be investing in Roth IRA, but his investment would still accrue interest

In the 21 st year, the value of Roth IRA investment would be = $172980.23 X (1+8%) = $ 186,818.64

However the whole life policy would have paid $200,000 at death.

The buy in cash policy (Whole life policy), which would pay $200000 is better than "Invest the difference" policy which would accumulate $186,818.64

C.

Buy the Cash value policy would pay $200000 at death.

If stephen chooses a 25 yr term policy and invest the difference for 20 years in Roth IRA, the value of investment at the year end 26 (one year after term policy expires) is the Future value of investments done till year 20 and grown at 8% thereafter

Here, we will use excel functiuon FV or same can be applied in financial calculator

Rate = 8%

NPER = 6 (6 years after 20 years)

Investments = PMT = 0 (No investment after year 20)

PV = Present value of investments at year 20 = $172,980.23 (This investment would continue to earn returns at 8%)

Type =1

Future Value = FV(8%,6,0,172980.23,1) = $274,497.89

Therefore invest the difference in Roth IRA is a better choice

D.

In an traditional IRA, the capital gain is taxed

Thus in previous case, the FV value of investment was $274497.89

The investments are $3500 x 20 = $70,000

Capital Gain = $274497.89 - $70000 = $204497.89

Now this gain would be taxed at 24% = 24% x $204497.89 = $49079.49

The real value of investment would be $274497.89 - $49079.49 = $ 225418.39

The decision would still be same, Invest in the difference


Related Solutions

Sara Woodyard, age forty-four, plans to retire at age sixty-seven. Her life expectancy, accounting for family...
Sara Woodyard, age forty-four, plans to retire at age sixty-seven. Her life expectancy, accounting for family medical history, is age ninety-seven. Tara is single and currently earns $56,000 per year as a university librarian. At her normal retirement age, she expects to receive $28,700 in Social Security benefits (today’s dollars). She will also receive a small defined benefit pension in the amount of $13,500 from a local municipality. She has come to you to determine whether she is on track...
Ann E. Belle is age 45 and plans to retire in 20 years (at age 65)....
Ann E. Belle is age 45 and plans to retire in 20 years (at age 65). She has retirement savings in a mutual fund account, which has a current balance of $150,000 (Ann does not plan to add any additional money to this account).  Also, Ann opened a 401K retirement account with her new employer and will contribute $15,000 per year into her 401K until retirement.   If Ann’s mutual fund account grows at an annual rate of 8.0% how much money...
Ann E. Belle is age 45 and plans to retire in 20 years (at age 65)....
Ann E. Belle is age 45 and plans to retire in 20 years (at age 65). She has retirement savings in a mutual fund account, which has a current balance of $150,000 (Ann does not plan to add any additional money to this account). Also, Ann opened a 401K retirement account with her new employer and will contribute $15,000 per year into her 401K until retirement. solve question algebraically and show work. 1.)If Ann’s 401K account grows at an annual...
4. To retire at a decent age and move to Hawaii, an engineer plans to trust...
4. To retire at a decent age and move to Hawaii, an engineer plans to trust her account to an investment firm that promises to make a real rate of return of 8% per year when the inflation rate is 2% per year. The account currently is valued at $290,000 and she wants to retire in 12 years. Determine how much (in then-current dollars) will be in the account for the realized rate of return to be a real 8%...
Today is Sofia’s 35th birthday. She plans to retire in 32 years at the age of...
Today is Sofia’s 35th birthday. She plans to retire in 32 years at the age of 67, with expected life expectancy of 30 years after that. To maintain her life style, she thinks she will have to withdraw $8,000 from retirement account at the beginning of each month during retirement. Meanwhile, she plans to donate $100 to charity starting on her 70th birthday, and the monthly payment will continue till she passes away. In addition, she would like to establish...
1. George is currently 30 years old, plans to retire at the age of 65 and...
1. George is currently 30 years old, plans to retire at the age of 65 and to live to the age of 85. His labor income is $25,000 per year, and he intends to maintain a constant level of real consumption spending over the next 55 years. Assume no taxes, no growth in real salary, and a real interest rate of 3% per year. a. What is the value of George’s human capital? b. What is his permanent income? c....
5.Kate plans to retire at age 60. At that time, she wants to have enough to...
5.Kate plans to retire at age 60. At that time, she wants to have enough to invest in a travel account so that she can go on a world trip every four years until she reaches 76, i.e. at ages 64, 68, 72 and 76. Each trip will cost $10138. If the interest rate is 4.9% p.a. compounded quarterly, how much should she deposit in the travel account at age 60. (Give your answer to the nearest cent, omitting the...
The time (in years) after reaching age 60 that it takes an individual to retire is...
The time (in years) after reaching age 60 that it takes an individual to retire is approximately exponentially distributed with a mean of about five years. Suppose we randomly pick one retired individual. We are interested in the time after age 60 to retirement. a. Define the random variable. X= _________________________________. b. IsXcontinuous or discrete? c. X~ = ________ d. μ= ________ e. σ= ________ f. Draw a graph of the probability distribution. Label the axes. g. Find the probability...
Rick is currently 35 years old. He plans to retire at age 65 and hopes to...
Rick is currently 35 years old. He plans to retire at age 65 and hopes to live to age 85. His labour income is $50,000 per year, and he intends to maintain a constant level of real consumption spending over the next 50 years. Assuming a real interest rate of 3% per year, no taxes, and no growth in real labour income, what is the value of Rick’s human capital? ****I would like this broken down step by step, and...
Your dad is now 55 years old and plans to retire at age 70. He currently...
Your dad is now 55 years old and plans to retire at age 70. He currently has a stock portfolio worth $450,000. The portfolio is expected to earn a return of 8 percent per year. b. Assume he plans to invest an additional $12,000 every year in his portfolio for the next 15 years (starting one year from now). How much will his investments be worth when he retires at 70? c. Assume that your dad expects to live 20...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT