Hi Guy, I got question on the below and need your help. The help i need is in the highlighted statement.
Elisa Lima is a 34-year-old widow residing in a country that uses U.S. dollars (USD) as its currency. She has two children: age 10 and age 6. Lima works as the director of marketing at Relex Corporation. Exhibit 1 presents details of the financial environment in Lima’s home country. Exhibit 1 Selected Data from Lima’s Home Country Taxes Flat income tax rate of 25%. Wages, realized capital gains, and interest are taxed as income. Dividends are not taxed. Realized losses may be offset against income and may be carried forward to offset income in future years. Health insurance Government provides at no direct cost to citizens. Tax-deferred accounts (TDAs) Contributions are pretax and annual maximum is USD 40,000. Income and gains grow tax-deferred and portfolio reallocations are not subject to tax. Income taxes are paid on full amount of withdrawals. No penalties on withdrawals for housing or education. Lima’s current pretax annual compensation is USD 140,000 and her current annual living expenses are USD 96,000. Her future salary increases are expected to match any increases in living expenses on a pretax basis. Lima is in good health, owns her home, and has no debt. Lima is a disciplined investor, but a recent equity market decline caused her great anxiety. She is worried about her ability to fund her children’s education and her retirement. Lima meets with her financial advisor, Mark DuBord, to review her financial plan. DuBord notes the following factors: Lima invests USD 12,000 (pretax) in a TDA at the end of every year and intends to continue doing so until she retires. The current value of the TDA is USD 250,000. Lima makes annual contributions to charity of USD 6,000. These contributions are included in her annual living expenses. She will prepay her children’s future education costs at the end of this year. Lima participates in Relex’s executive retirement program. At the mandatory retirement age of 60, she will receive a pretax payment of USD 1,000,000. DuBord determines that the prepaid education costs for both children will require a total of USD 50,000, including all taxes.He recommends that Lima purchase a life annuity to fund her retirement. DuBord calculates she will need USD 3,000,000 (pretax) to purchase the annuity at age 60. Lima agrees with DuBord’s recommendation. Calculate Lima’s required average annual pretax nominal rate of return until her retirement in 25 years. Show your calculations. Answer are as below: PART B i.Return Objective Statement Limas return objective is to grow the investable tax-deferred portfolio to purchase a USD 3,000,000 pretax annuity in 25 years at age 60. Since she will receive a pretax payment of USD 1,000,000 upon retirement from Relex, the investment portfolio needs to provide USD 2,000,000 of the necessary USD 3,000,000. Limas expenses are USD 96,000. Given the tax rate of 25%, Lima will need 96,000 / (1 - 0.25) or USD 128,000 of pre-tax income to generate the after-tax income for meeting these expenses. Therefore Limas current pretax annual compensation of USD 140,000 will support a taxdeferred contribution of 140,000 128,000 or USD 12,000. Limas income is expected to grow with her expenses over the remainder of her working life; therefore, the USD 12,000 contribution to the TDA can be continuedannually. ii.Return Calculation Investment Portfolio (pretax) Current portfolio USD225,000 Assets Needed to Purchase Annuity at age 60 (pretax) Required portfolio value 3,000,000 Lump-sum benefit at age 60 1,000,000 Required value of TDA 2,000,000 Required Return Calculation Present Value (PV) (225,000) Future Value (FV) 2,000,000 Annual Savings (PMT) (12,000) Number of Years (N) 25 CPT I/Y TVM registry of calculator 7.05% pretax nominal
My question is What will the answer be if DuBord calculates she will need USD 3,000,000 (After tax ) to purchase the annuity at age 60.