Individual IPS: Adjusting for the tax rate

Clearly we always adjust the required return to inflation if we are asked to provide the nominal return, but is there a rule of thumb as to when you need to divide the required return by (1-tax rate)? I’ve seen certain answers that have that calculation and others that don’t. What word or phrase in the vignettes should trigger such a calculation? Thanks in advance.

((1+r)(1+i)-1)/(1-t) r=pre-tax rate of return i=inflation t=tax rate Living expenses are always after tax, if their portfolio is taxable an adjustment needs to be made.

So in which scenario would the adjustment not have to be made? I don’t have the books in front of me right now, but I remember several problems where the schweser answer didn’t make the adjustment.

they typically ask for pre-tax return, or after-tax return. thats been my experience from schweser and cfai problems/exams recall that endowments/pensions/foundations are tax exempt; everyone else needs to pay the piper, retired or not.

I believe the exam will specify the answer it’s looking for.

in some quetions we also multiply the $$ spending with the inflation rate then do ((1+r)(1+i)-1)/(1-t). any comments on this?

If no inflation number is given, don’t include it in your calculation and don’t assume a number. If no tax rate is given, don’t include it in your calculation and don’t assume a number. More than likely, a tax rate will be given. The problem will state whether you need to compute the before-tax return or the after-tax return. I find the after-tax returns easier. I get all the cashflows in after-tax terms and then compute the return. Then you can covert it if necessary. In some cases, it may be easier to work from a before-tax standpoint depending on what cashflows there are. Basically all expenses are after-tax. Most salaries and other income are before-tax. Watch out for tricks about what should be taxed and what shouldn’t. Some of the old exams have problems where certain investment incomes were taxed and others weren’t. You need to pay close attention to this stuff. It is up to you how to account for inflation (if it is given). You can either include it in the return calc or add it to the real return. Either way should be fine and they both give relatively close answers. If they don’t ask for a nominal return, then don’t adjust for inflation.

Very helpful hezagenius. Thanks a bunch!

tsx11 Wrote: ------------------------------------------------------- > they typically ask for pre-tax return, or > after-tax return. thats been my experience from > schweser and cfai problems/exams > > recall that endowments/pensions/foundations are > tax exempt; everyone else needs to pay the piper, > retired or not. Foundations can be taxable entities. watch out…they aren’t too tax sensitive since its 1% of investment income for private foundations, but it still exists

I thought there was some other tax on Foundations too. Unrelated business income?

unrelated business income is taxed at regular rate

I wonder if they’d try to trick us by having a foundation not make its spending rate and therefore become taxable?