CFA 2012 AM: Alonso (football manager) - tax-exempt account

The passage says the following:

  • 25,000 annual saving from his after tax salary

  • His investments are in a tax-exempt account where contributions are made after tax

When computing the required return, the answer assumes he can contribute the full 25,000 into the account.

I answered it wrong because I thought tax needs to be applied when injecting the fund into the account. Since the question did not mention the tax rate, I assumed it to be the 30% income tax rate Alonso had.

I know the 30% income rate is not necessarily the account tax rate, but still there should be a tax to be applied.

Is it a poorly written question or is it just me…?

“25,000 annual saving from his after tax salary” It pretty much spells it out for you right there. The 25,000 deposits are AFTER tax savings in a tax exempt account. Tax no longer applies

I have a different understanding (maybe just me?):

“After tax salary” is the salary after income tax. But it does not include the tax that you use the salary on something else.

For example, I would say my saving from after tax salary is 25,000, but i won’t deduct the VAT from it even if I plan to buy a car with the saving. (so it is after income tax, but not after all tax associated with what I intend to spend with it)

You’re making this way more difficult than it really is. The 25,000 is an after tax savings. The only intention for that money is for saving for retirement. We’re here to help manage it. This is after he spends his after tax income on necessary and discretionary expenses. You’re not going to have to conjure up some value added tax out of thin air. Everything you need to answer an IPS question will be spelled out for you. We’re not car salesmen on exam day, we need not worry about VAT on a car. If they want you to consider a special cash purchase with a separate tax, they’ll give you all the info you need.

It was just an analogy. My confusion stemmed from the difference between between after-tax saving and after-tax contribution. What it spells out is after-tax saving, didn’t say it is after the contribution.

If the question tells you contribution to the account has a tax rate of 20% at time of contribution, would you apply it or do you think “it spells out for you that the 25,000 is after tax”, and ignore the 20% ?

With the previous exams it is quite clear that CFAI doesn’t like to spell things out to you. They trip you from time to time if you forget one bit of details.