Question

You are a financial planner for Kelly Roberts. Kelly has just started a new job as an IT programmer for the Australian government. They will pay her a salary of AUD$70,000 p.a. She expects her salary to grow at 3% p.a. each year based on previous data. Inflation in Australia is 1%. After a detailed discussion, she has decided that she will deposit 20% of her salary by automatic withdrawals: half into a TFSA; half into a taxable account. The income on the TFSA is never taxed. The income in the taxable account is taxed at 35% p.a. She is an aggressive investor who expects a nominal annual return of 8% p.a. on both accounts.

a) Calculate the following amounts after 8 years, all payments made at year end.

1. The nominal value in the TFSA
2. The after-tax nominal value in the taxable account

b) Explain to Kelly, using calculations, whether inflation is a major concern for her investments or not.

c) Explain to Kelly two assumptions you have made in your calculations and explain two examples which would make your calculations inaccurate.

Answer 1

Following are the solutions to the 3 sub-sets of the problem for which calculations (done on excel) are mentioned in table mentioned below:

a. The Nominal value in the TFSA and after-tax nominal value in the taxable account is AUD $ 69243 and AUD $ 45008 respectively and the calculation is shown below:

Salary growth	3%	Tax	35%	ROI	8%
	Salary
	Y0	Y1	Y2	Y3	Y4	Y5	Y6	Y7	Y8	Cumulative
Total Annual Salary	70,000	72,100	74,263	76,491	78,786	81,149	83,584	86,091	88,674
Automatic withdrawal	14,000	14,420	14,853	15,298	15,757	16,230	16,717	17,218	17,735
TFSA	7,000	7,210	7,426	7,649	7,879	8,115	8,358	8,609	8,867	64,114
8% ROI on TFSA Accnt	7,000	7786.8	8020.404	8261.016	8508.847	8764.112	9027.035	9297.846	9576.782	69,243
Taxable accnt	7,000	7,210	7,426	7,649	7,879	8,115	8,358	8,609	8,867	64,114
After-tax taxable accnt	4,550	4,687	4,827	4,972	5,121	5,275	5,433	5,596	5,764	41,674
8% ROI on after-tax taxable Accnt	4,550	5,061	5,213	5,370	5,531	5,697	5,868	6,044	6,225	45,008

b. Inflation impacts on her investment can be explained from the calculations mentioned below:

Inflation	1%
	Salary
	Y0	Y1	Y2	Y3	Y4	Y5	Y6	Y7	Y8	Cumulative
Total Annual Salary	70,000	72,100	74,263	76,491	78,786	81,149	83,584	86,091	88,674
Salary actual value post 1% Inflation	70,000	72,821	75,006	77,256	79,573	81,961	84,419	86,952	89,561

The actual value of the salary due to 1% Inflation is marginally higher which can be neglected as Kelly is a aggresive investor and 8% YOY growth on her investment is way greater than the marginal growth due to Inflation. So, It is not a major concern for her.

c. The two assumptions were made while deducing to the calculations shown above are :

1. There is no big investment made during the span of 8 years such as purchase of House, Higher education cost, or Vacationing to other countries.

2. There is a consistency in the investment plan made which gives an ROI of 8%, Tax ragime of 35%, and Inflation of 1%. Any Changes in the above can impact the figures mentioned above heavily.

Hope, the above solution resolves the query.