Case Study 1 Solution
Introduction
- Calculate the current cost of Jazz’s college education
True interest = Nominal interest - Inflation interest
= 0.07 - 0.03
= 0.4%
0r
True interest rate + 1 =
R= Real Interest Rate
r= nominal interest rate
i = inflation interest rate
= 0.07 - 0.03
= 0.4%
0r
True interest rate + 1 =
R= Real Interest Rate
r= nominal interest rate
i = inflation interest rate
= 1 +0.07 / 1 + 0.03
= 3.88%
Amount = $20000 * 5
=$ 100000
Present Value = FV ( 1 + I )-n
= $100000 (1 + 3.88%)-18
=$ Answer 1
- Calculate the capital
needs of the couple at retirement
and current value of their retirement needs
100yrs – 67yrs = 33yrs
Total capital needed= 33yrs * $ 150,000 per
year
= $ 4,950,000
$4,950,000
True interest rate + 1 =
= R
Present Value = $ 4,950,000 * ( 1 + R) -42
=$ Answer 2
- Provide the couples with their goals
with the current total amount needed to reach their goals showing how you
arrived at the total
Goals = retirement amount needed + college
fee
= $Answer 2 + $ 51192
=$ Answer 3
Social Security = $ 40,000
Present value =
40000 * (1 + R)-42
= 2360
401(K) savings = $5000 * (67yrs – 25yrs)
= $ 210,000
Present value = 210,000
* ( 1 + R)-42
=12394
Current savings = $ 100000
Total savings =
100000 + 2360 + 12394
= $114754
Goals = $ 376,054
Difference = ( $
261,300)
The couples do not have sufficient funds to
meet their goals as from the calculations above shows that the current savings
are not enough to meet their goals by $ 261, 300. As per their current savings they will have $
114,754 while their requirement is $ 376,054. This simply means that they are
short by the same amount.
- Using calculations and
explanations provide the couple with three alternatives for meeting their
goals.
I.
Reduce their need after
retirement for example by $ 40,000
100yrs – 67yrs = 33yrs
Total capital needed= 33yrs * $ 40000 per
year
=$ 1,320,000
True interest rate + 1 =
= R2%
Present Value = $ 1320000 * ( 1 + R2) -42
=$ 83615
Difference from $150,000
= $ 292438 which
will compensate for the 261,300 difference
ii) Increase current savings by $ 261300
This is the same difference by which they are
short, if they do this the difference will be zero thus they will be able to
meet their difference.
iii) Increase their 401 (k) savings by $ 6198
per year for the next 42years
6198 * 42 = $260300
This will also compensate for the difference
needed to meet their goals.
- In your own words
provide the couples with the
advantages and disadvantages of two accounts and/or investments
instruments that are used to specifically save for college education
expenses . which would you recommend.
a.
Qualified Tuition Program
Advantages of this is that
there is no income limit for the
contributors ( Jerry and Jenny) thus they can contribute whatever their income
is. Another advantage is that they are also tax free meaning they will not be
taxed on the amount contributed which reduce their tax expenses leaving them
with more income.
The disadvantages include that incase of a withdrawal fom a plan,
the amount will be taxed and also it generally requires that the amount be used
before the beneficiary turns 30 years of age (Wasik,
2014).
b.
Coverdell Education Savings Account
An advantage of the Coverdell is that it can be used for k-12
related expenses as well as higher education expenses (United States of America Patent No. US20060167780 A1, 2006).
Distributions are also not included included in the beneficiary’s income as
long as they are used for qualified education expenses.
The disadvantage of this is that it is limited to $ 2,000 per
beneficiary regardless of the number of contributors that might be available in
our case it is only Jenny. To add to that, with a Coverdell there might be be
fees associated withopening and maintaining an account.
References
Friedman, G. (2006, July 27). United States of
America Patent No. US20060167780 A1.
Wasik, J. (2014, november 4). The Five Best College
Saving Plans. Forbes, 1-2. Retrieved from www.forbes.com
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