Ashwin Wrote: ------------------------------------------------------- > okay, the question that I originally posted is > simple. If we have $1M portfolio, $50K liquidity > needs, 3% inflation and 30% tax rate, what is my > PRETAX return requirement? > > Method 1: (living expenses + Inflation rate) / > (1-t); (5%+3%) / 70% = 11.4% > Method 2: ((living expenses / (1-t)) + Inflation > rate; (5%/70%) + 3% = 10.1% > > Which one is the correct answer? In other words, > do we add inflation to living expense before we > calculate tax effect OR we calculate tax effect on > living expense first and then add inflation on top > of it? As CMP pointed out, if the question specifically states that cap gains are taxed annually, you will use the first formula and say 11.4%. But if the question does not mention anything or states that cap gains can be deferred, then use the second formula and give them 10.1% does it make sense?
^ it makes sense intuitively but they usually don’t tell you whether the return is taxed annually or deferred till withdrawal in the IPS questions. Do they?
Ashwin Wrote: ------------------------------------------------------- > ^ it makes sense intuitively but they usually > don’t tell you whether the return is taxed > annually or deferred till withdrawal in the IPS > questions. Do they? More times than not, our capital gains are allowed to be deferred… so I would use the second formula, if nothing is mentioned in regards to how the account is taxed.
I dont exactly know whats going on with anything after the first thread, but this could make it clear to you The way i see it is the first calculation was initially calculated using Nominal PreTax Return therefore living expenses would have been increased at the time that you payed taxes by the amount of inflation Second formula was initially calculated as Real PreTax Return so the inflation would not have been included in your initial calculation, so so adding it in before reversing it would have changed the answer but thats just what i took to be the application of the different formulas
TheDon Wrote: ------------------------------------------------------- > I dont exactly know whats going on with anything > after the first thread, but this could make it > clear to you > > > The way i see it is the first calculation was > initially calculated using Nominal PreTax Return > therefore living expenses would have been > increased at the time that you payed taxes by the > amount of inflation > > Second formula was initially calculated as Real > PreTax Return so the inflation would not have been > included in your initial calculation, so so adding > it in before reversing it would have changed the > answer > > but thats just what i took to be the application > of the different formulas i disagree with your statements…
I am always going with : Return = ((living expenses / (1-t)) + Inflation rate
Does any one have the problem where they use (AT expense + inflation)/(1-T) equation?
Damn, just did this wrong on the 2009 exam. Seriously hurting my score! I have no clue whatsoever what to use. They already added tax to the liability (45.000 / 80%) before they calculated return. Immediately calculating before tax return. I’m just hoping they will ask for after tax return… By the way, any of you got scared when you saw the 2009 exam? This little trick, Implied Assets and Liabilities, Grinold-Kronor division with an exhibit where they seem to name everything different yet again. My god… I hate the exam makers.
Thought I had this nailed but now super confused like you all…which order do we go in? Calculate real after tax req return, add inflation to get nominal after tax req return then divide by (1-t) to get nominal pre tax return? Or calculate real after tax req return, divide by (1-t) to get real pre tax return then add inflation to get nominal pre tax req return?
Summary: Return = (living expenses + Inflation rate) / (1-t) - FOR ACCRUAL TAXES ON CAP GAINS Return = ((living expenses / (1-t)) + Inflation rate -FOR TAXES ON WITHDRAWALS But don’t use these arithmetic formulas anyways, go with geometric. Ben
geometric on CFAI '08 AM #4 part ii cost me points! anyone has the question where you are asked to gross up inflation by tax? thnx
The Schweser mock exam actually has a slightly different calculation for this… Answer to Question 6A on Exam 2 (morning). It shows: return = ( (1+spending)*(1+ inflation) ) / (1-tax)
The equation is actually: return = ( (1+spending) * (1+inflation) - 1 ) / (1 - tax) I don’t think there is ever a time where using geometric linking is a problem. In this specific problem, it does not say whether there are annual taxes or not either (TDA v. non-tda).
Thanks dcbreber, that is how I always had done these problems
Sorry tigercfa but I have to change my mind on this… the equation before is correctly taken from Schweser. This is inconsistent however with the calculation shown on the 2009 actual level III exam for problem 1.A.i… The problem effectively takes ((spending / (1-t))+1 * (1+inflation). I dont know about anyone else, but I am going with what the CFA answer shows. On this problem if you used the Schweser method, you would have gotten 10.85% required pretax return using geometric linking v. the actual answer of 9.86% (using rounded 5.63% spending requirement).