Question

The questions below also rely on the following assumptions: (reference the Tax Cuts and Jobs Act of 2017)

You are 30 years old and your employer sponsors a 401(k) plan with a 4% employer match.
You earn $100,000 of gross wage income. This income is expected to stay constant over the next three years.
At the start of every year you decide to invest 4% of your salary into your 401(k).
Your expected return on your investments is 5% per year.
You file your taxes as a single filer and you are in the 24% tax bracket.
The long term capital gains tax is 15%.
1. Calculate the total amount of funds that you expect to be in your 401(k) at the end of three years. Explain your answer.
2. At the end of the third year, you decide to withdraw $15,000 from your 401(k) to pay for some home improvements. Calculate how much tax, if any, you will owe on this withdrawal. Explain your answer.
3. During this same three year period you also invested in a Roth IRA. At the end of this three year period, your Roth IRA had cumulative contributions of $15,000 and earnings or gains of $5,000.
Suppose you decided to fund your home improvements by withdrawing from your Roth IRA instead of your 401(k). Calculate how much tax, if any, would you owe in this withdrawal. Explain your answer.

Answer 1

1. The total amount of funds that you should expect to be in your 401(k) at the end of three years is:

$26,481.00.

This is the future value of $8,000 invested at the beginning of the year for 3 years (principal of $24,000 plus interest of $2,481).

2. Tax liability on this withdrawal = $3,600 ($15,000 * 24%). This is based on the amount withdrawn multiplied by the taxpayer's tax rate of 24%. The taxpayer does not pay tax on his contributions. Instead, tax is paid on withdrawals from the 401(k) plan unlike ROTH.

3. No tax would be paid on the withdrawal for home improvements. Tax is also not paid on the gain because tax has already been paid before the investment is made into the ROTH fund.

Step-by-step explanation:

a) Data and Calculations:

Gross wage income = $100,000

Investment in 401(k) = $4,000 ($100,000 * 4%)

Employer's match in 401(k) = $4,000 ($100,000 * 4%)

Total annual investment in 401(k) = $8,000

N (# of periods) 3

I/Y (Interest per year) 5

PV (Present Value) 0

PMT (Periodic Payment) 8000

Results

FV = $26,481.00

Sum of all periodic payments =$24,000.00

Total Interest $2,481.00

Roth IRA cumulative contributions = $15,000

Earnings or gains on the Roth IRA fund = 5,000

Tax liability on the withdrawal = $0 ($20,000 * 0%)