Answer to Question #349697 in Financial Math for Angel

Question

Both Maria and Firdaus are salaried individuals. They are saving for their retirement 20 years from now. Both of them are also in the 28% marginal tax bracket. Maria makes a $2000 contribution annually on December 31 into a savings account (subjected to tax) earning an effective rate of 8% per year. At the same time, Firdaus makes a $2000 annual payment to an insurance company (tax-sheltered) for an after-tax-deferred annuity. The annuity also earns interest at an effective rate of 8% per year. (Assume that both of them remain in the same tax bracket throughout this period, and disregard state income taxes.)

Calculate how much each of them will have in their investment account at the end of 20 years.

Compute the interest earned on each account.

Show that even if the interest on Firdaus’ investment were subjected to a tax of 28% upon withdrawal of his investment at the end of 20 years, the net accumulated amount of his investment would still be greater than the net accumulated amount of Maria’s investment.

Answer 1

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