Reference no: EM132709625

A 401(k) plan offers individuals the opportunity to save money tax-free while they are working. Currently, the government allows you to save $19,500 per year before tax. Typically the government increases the contribution limit each year with inflation, which you expect to be 2% per year for the foreseeable future. However, you cannot withdraw funds from your account without a significant financial penalty until you turn 70 years old. Assume you are set to graduate from RPI in December and start a new job in January that offers a 401(k). Further assume that you just turned 22 years old and you plan on contributing the maximum amount to your 401(k) each year until you can withdraw funds at 70 years old (which you can assume will be exactly 48 years from the time you start saving). Assume that you earn a constant effective annual rate of return of 7% per year on your investment.

Problem 1. If you make 24 equal contributions each year to max out the benefits, how much will you have in your account when you turn 70 years old? (Assume you make semi-monthly payments at the middle and end of each month.)

Problem 2. Assuming you pay a marginal tax rate of 35%, which you expect to remain constant forever, what are the tax benefits of the 401(k) plan over your working life?