adjustment for inflation - pre tax or post tax?

CFA Level III
#1

I was under the impression that inflation adjustment is to be made post tax as this return is also taxable

But In 2009 AM mock (CFAI), for the return calculation in the 1st question, they have added inflation to the pre tax return. Really suprised.

Should we add inflation pre tax or post tax?

One possible explanation could be that if it mentions “maintain real value of assets” then we can add inflation pre tax as we can defer the tax on this return. And if it mentions “expenses will increase with inflation” then we add inflation post tax.

Does this make sense? Someone please clarify.

Thanks

#2

http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91321678

2009 triped me as well but i think CFAI lately is using tax after inflation method…which is more correct i believe

But say in 2009 u used this method i strongly believe that u would receive full credit

#3

I’m hoping for the benefit of the doubt on these as well. You just don’t want to forget to factor it in.

#4

The discussion in the link said that it should be mentioned in the question whether only withdrawals or all gains are taxed.

So I will go by what the question would say or add inflation post tax if nothing is mentioned (which would be more conservative)

Thanks for the help, banebt

#5

anks, read what the thread says gain. Default case should be apply taxes AFTER inflation.

#6

Here’s what S2000magician said about it:

I’ve been told that CFA Institute’s default position used to be that accounts were not taxable; I’ve been told that CFA Institute has changed their default position to accounts being taxable.

What I understand is that by default, returns to cover inflation are to be taxed even if they are not withdrawn. This has changed from earlier position of CFAI.

Correct me if I am wrong.

#7

What you said is correct. However, you must lever up for taxes AFTER adding inflation to accomplish this.

2009 Example: This was a non-taxable account (old default). Lever up for taxes THEN apply inflation.

New Default: Taxable account, thus return due to inflation must be taxed. Add inflation THEN lever up for taxes.

#8

In my experience, CFA Institute is very clear whether the account is taxable or not.

In another thread on this topic (one of many), I posted examples from several of the most recent CFA exams; if you do a search for “inflation” you’ll likely find it.

#9

That thread (specifically your post with examples) cleared this issue up once and for all. If any of you still are confused about this, LOOK UP THAT THREAD.

EDIT: Here it is: http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91321885

#10

Magician, from the volume of posts on this particular topic, it is evident that the CFAI Text fails to provide clear guidelines for the required return calculation. You made a very blury subject for myself (and others) make sense. Thank you.

#11

My pleasure.

Glad I could help.

#12

If you think about this topic in terms of ‘inflation’ being taxed, you’re going to get yourself in a world of hurt.

Inflation isn’t taxed, returns are. Inflation is a return requirement (if the investor seeks to maintain purchasing power), not a separate fund. Ie, I need to earn 10% annually, and 2% to cover inflation, for 12% (additive). I don’t earn 10% return and 2% inflation, I need 12%. A heuristic probably won’t work in solving these provblems.

Whether its taxed is a location and timing question that needs to be considered individually - there is no guideline answer because not all situations adhere to a guideline.

Magician’s doing a fantastic job of saying to read the vignette and f you’re still confused, re-read the vignette.

#13

kwalew, I just corrected to “returns” due to inflation. I though that fact that inflation itself wasn’t taxed was understood.

#14

It is a given, but to the OP’s original question, this is a timing and algebra problem, not a simple rule of thumb.