Investment Choice
Essay by people • March 5, 2011 • Case Study • 1,756 Words (8 Pages) • 2,283 Views
Part A
As I planned to retire on my 66th birthday, I have to decide what and when should I invested my annual income to different investment vehicles so as to maximize the wealth in 15 years later. Given the following financial information, I always have 60% of income that can be invested into different investment vehicle.
1. My income on 51 year old is $100,000 and is expected to grow at 6.08%
2. I planned to consume 40% of my income every year
3. The income tax rate is 33% throughout my investment period
There are 4 different investment vehicles with different tax and return features, and summarized as following:
Keogh plan:
- Maximum amount invested in Keogh plan is capped at 20% of annual income
- Additional 10% tax will be imposed if the position in Keogh before 59.5 year old
- Fund invested in a Keogh account accumulate investment income tax-free and tax will be imposed when fund withdraw from the account
- Return on Keogh plan is 6.08% per year
Deferred Annuity:
- Return on Deferred Annuity is 6.08% per year
- Fund invested in deferred annuity is not tax-deductible
- Income earned on the contract accumulates tax-free and only interest is taxed on withdrawal
- Partial withdrawals are treated as interest first
Municipal bond:
- Return on municipal bond is 6.08% x (1-0.28) per year
- It priced such that the implicit tax rate is always 28%
Money Market Saving:
- Return is 6.08%
- No special tax feature
Given above investment vehicles features, the per dollar return can be structured as Table A. From Table A, it is always optimal to invest 20% of the income into Keogh account as it gives highest return among all investment vehicles. And the residual after tax income should be invested into Deferred Annuity on or before 56st birthday and invested into Municipal Bond on or after 57th birthday to maximize the wealth at retirement. By allocating the annual income according to this investment strategy, the total wealth accumulated on my 66th birthday will be equal to $990,380
Birthday Years to Liquidation (N) MoneyMkt Muni Annuity Keogh
51 15 1.8202 1.9016 1.9540 2.4238
52 14 1.7489 1.8218 1.8609 2.2849
53 13 1.6805 1.7454 1.7731 2.1540
54 12 1.6147 1.6722 1.6904 2.0305
55 11 1.5515 1.6021 1.6125 1.9141
56 10 1.4908 1.5349 1.5390 1.8044
57 9 1.4324 1.4705 1.4697 1.7010
58 8 1.3763 1.4088 1.4043 1.6035
59 7 1.3225 1.3497 1.3428 1.5116
60 6 1.2707 1.2931 1.2847 1.4250
61 5 1.2210 1.2389 1.2300 1.3433
62 4 1.1732 1.1869 1.1784 1.2663
63 3 1.1273 1.1372 1.1298 1.1937
64 2 1.0831 1.0895 1.0839 1.1253
65 1 1.0407 1.0438 1.0407 1.0608
66 0 1.0000 1.0000 1.0000 1.0000
Table A: Per dollar return of different investment vehicles
Part B
Since the funds invested in the deferred annuity accumulate interest at 0.25% less than the rate on fully taxable bonds which is 5.83% (6.08%-0.25%), because of administrative costs add to this vehicle. Other things remain unchanged in part A. The per dollar return of different investment vehicles is thus different from part A.
Birthday Years to Liquidation (N) MoneyMkt Muni Annuity Keogh
51 15 1.8202 1.9016 1.8975 2.4238
52 14 1.7489 1.8218 1.8111 2.2849
53 13 1.6805 1.7454 1.7296 2.1540
54 12 1.6147 1.6722 1.6525 2.0305
55 11 1.5515 1.6021 1.5796 1.9141
56 10 1.4908 1.5349 1.5108 1.8044
57 9 1.4324 1.4705 1.4457 1.7010
58 8 1.3763 1.4088 1.3843 1.6035
59 7 1.3225 1.3497 1.3262 1.5116
60 6 1.2707 1.2931 1.2713 1.4250
61 5 1.2210 1.2389 1.2194 1.3433
62 4 1.1732 1.1869 1.1704 1.2663
63 3 1.1273 1.1372 1.1241 1.1937
64 2 1.0831 1.0895 1.0804 1.1253
65 1 1.0407 1.0438 1.0391 1.0608
66 0 1.0000 1.0000 1.0000 1.0000
Table B: Per dollar return of different vehicles (return on Annuity adjusted)
From Table B, the return of deferred annuity after adjustment is always lower than Municipal bond and it is always optimal to invest 20% of the income into Keogh account and the rest of income will invest into municipal bonds to maximize the wealth at retirement. By allocating the annual income according to this investment strategy, the total wealth accumulated on my 66th birthday will be equal to $988,129.
Part C
I assume to take a one-year unpaid sabbatical leave following my 57th birthday to retool, and will consume $60,000 on my 58th birthday. The retooling will enable me to increase myself-employment income by 20% relative to what it otherwise would have been during my remaining working years. Therefore, the annual income to be received on 59th birthday will be:
Investment Strategy Analysis
i) For the whole period between 51-66
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