Sep 27, 2017 term paper 2

MR X HAS JUST TURNED 50 YRS OLD AND WISHES TO PLAN FOR HIS RETIREMENT AT THE AGE OF 60 IN TEN…

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Mr x has just turned 50 yrs old and wishes to plan for his retirement at the age of 60 in ten years’ time .He is considering either investing K90,000 at the end of each year over this 10 year period in a  mutual fund k1,500,000 per annum in all -equity retirement fund.

 

Mr X is on the marginal tax rate of 40% and his annual contributions to the retirement fund will be fully deductible.you may assume that any tax benefit will be realized at the same as the contribution during the initial ten year period.His annual annual contribution to the mutual fund is not tax deductible. In 10 years time, the total accumulated amount in the mutual fund  may be withdrawn and is subject to a tax rate of 10% of the difference between the cost and the selling price.If Mr X selects the retirement fund option, then the accumulated amount must be used to acquire the 10 year annuity which is taxable. Mr X retires,he expects his marginal tax rate to decrease to 30%.the financial institution,expects both the retirement fund and the mutual fund to grow at an annual compound rate of 9%over the initial period.the financial institution will be able to acquire a monthly annuity on mr x retirement,which will result in a return of 9% per annum,interest compound monthly.this reflects mr x required return on funds invested during his retirement period.you may assume that tax is payable once a yr,at the end of each yr.you may assume that the differences in transaction costs for the two options are immaterial.mr x is in a position that he will not pay tax on any mutual fund income.the mutual fund income is immediately re-invested,and forms part of the 9% annual return.required,determine whether mr x should select the retirement fund option or the mutual fund option based on the value relative to the cost of each alternative on retirement date if he wishes to maximize his after-tax wealth.


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