# IPS return calculation - the never ending confusion !!

guys i have beeb struggling to understand the proper treatment as far as salaries and living expenses are concerned…please some one help me put things in perspective… For calculating a pre tax return - - do we equate after-tax salaries with living expenses(plainly stated without saying whether before or after tax) or do we first divide living expenses by (1-tax rate) to arrive at pre-tax living expense value and then equate both to see if there is a shortfall or not…help mee…!!!

living expenses - after-tax salary = after-tax spending requirement Then divide the spending requirement by the total portfolio value to get the after0tax return, and then divide by 1-t to get the before-tax required rate of return.

The “pre-tax return” is just talking about the portfolio return. always tax salaries

Agreed -there is plenty of confusion! In Question 1 (B)(i) 2010 AM EXPENSES are grossed-up .This does not make sense because taxes are charged on income (and in any case question assumes that all expenses are not tax deductible) Just seems more logical,sensible to take taxes of income -ie Income is 140,000 -so after tax of 25% that would come down to 105,000.Given expenses of 96 000 that would leave only 9000 for annual contribution to savings(not \$ 12,000 as given in the answer) This is the CFA answer: PART B i. Return Objective Statement Lima’s 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. Lima’s 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 Lima’s current pretax annual compensation of USD 140,000 will support a taxdeferred contribution of 140,000 – 128,000 or USD 12,000. Lima’s 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 continued annually.

monk Wrote: ------------------------------------------------------- > Agreed -there is plenty of confusion! > > In Question 1 (B)(i) 2010 AM EXPENSES are > grossed-up .This does not make sense because taxes > are charged on income (and in any case question > assumes that all expenses are not tax deductible) > > > Just seems more logical,sensible to take taxes of > income -ie Income is 140,000 -so after tax of 25% \> that would come down to 105,000.Given expenses > of 96 000 that would leave only 9000 for > annual contribution to savings(not \$ 12,000 as > given in the answer) > > > > > > This is the CFA answer: > PART B > i. Return Objective Statement > Lima’s 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. > Lima’s 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 Lima’s current pretax annual > compensation of USD 140,000 will support a > taxdeferred contribution of 140,000 – 128,000 or > USD 12,000. Lima’s 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 continued annually. Its because with a tax DEFERRED account you pay in with pre-tax dollars and you only pay tax on the money you put in when you then take it out.

thanks

But we are talking about income which is taxed-yes?

Payment to the tax-deferred account is not taxed. Subtract 12000 from income. Multiply other 128 by .75 and income = expenses.

I’ve been getting confused with TDA withdrawals for housing expenses. In my experience, these types of withdrawals are never taxed, regardless if the question explicitly states their non-taxable nature or not. For one of the morning sessions, it was stated that withdrawals for housing and education are NOT PENALIZED. I still took the tax off because I didn’t equate tax with a “penalty.” In the morning session of the 2009 exam, a married couple withdrew 100,000 from a TDA for housing expenses and it was not taxed. Then they withdrew 200,000 for college expenses and it WAS taxed. Am I missing something here? I hate to lose points on something so stupid but they really seem to be inconsistent here. I almost hesitate to apply the tax rules to the letter of the law with these things due to this.

“In the morning session of the 2009 exam, a married couple withdrew 100,000 from a TDA for housing expenses and it was not taxed. Then they withdrew 200,000 for college expenses and it WAS taxed.” I would also like an answer to this.

mthmchris Wrote: ------------------------------------------------------- > “In the morning session of the 2009 exam, a > married couple withdrew 100,000 from a TDA for > housing expenses and it was not taxed. Then they > withdrew 200,000 for college expenses and it WAS > taxed.” > > I would also like an answer to this. The question reads: “they plan to pay off their mortgage and “associated TAXES” by withdrawing CAD 100,000 from their portfolio upon retirement.” "The arrangement, covering both sons, would require the Tracys to make a single payment of CAD 200,000 at age 60. " - No taxes mentioned. CFA was correct in what it did.

or we use “cash flow approach”: Cash inflow: -salary… -others cash outflow: -INCOME TAX PAYMENT -expense. -others.