Investment Choice

Part A

As I planned to retire on my 66th birthday, I have to decide what and when should I invested my annual income to different investment vehicles so as to maximize the wealth in 15 years later. Given the following financial information, I always have 60% of income that can be invested into different investment vehicle.

1. My income on 51 year old is $100,000 and is expected to grow at 6.08%

2. I planned to consume 40% of my income every year

3. The income tax rate is 33% throughout my investment period

There are 4 different investment vehicles with different tax and return features, and summarized as following:

Keogh plan:

- Maximum amount invested in Keogh plan is capped at 20% of annual income

- Additional 10% tax will be imposed if the position in Keogh before 59.5 year old

- Fund invested in a Keogh account accumulate investment income tax-free and tax will be imposed when fund withdraw from the account

- Return on Keogh plan is 6.08% per year

Deferred Annuity:

- Return on Deferred Annuity is 6.08% per year

- Fund invested in deferred annuity is not tax-deductible

- Income earned on the contract accumulates tax-free and only interest is taxed on withdrawal

- Partial withdrawals are treated as interest first

Municipal bond:

- Return on municipal bond is 6.08% x (1-0.28) per year

- It priced such that the implicit tax rate is always 28%

Money Market Saving:

- Return is 6.08%

- No special tax feature

Given above investment vehicles features, the per dollar return can be structured as Table A. From Table A, it is always optimal to invest 20% of the income into Keogh account as it gives highest return among all investment vehicles. And the residual after tax income should be invested into Deferred Annuity on or before 56st birthday and invested into Municipal Bond on or after 57th birthday to maximize the wealth at retirement. By allocating the annual income according to this investment strategy, the total wealth accumulated on my 66th birthday will be equal to $990,380

Birthday Years to Liquidation (N) MoneyMkt Muni Annuity Keogh

51 15 1.8202 1.9016 1.9540 2.4238

52 14 1.7489 1.8218 1.8609 2.2849

53 13 1.6805 1.7454 1.7731 2.1540

54 12 1.6147 1.6722 1.6904 2.0305

55 11 1.5515 1.6021 1.6125 1.9141

56 10 1.4908 1.5349 1.5390 1.8044

57 9 1.4324 1.4705 1.4697 1.7010

58 8 1.3763 1.4088 1.4043 1.6035

59 7 1.3225 1.3497 1.3428 1.5116

60 6 1.2707 1.2931 1.2847 1.4250

61 5 1.2210 1.2389 1.2300 1.3433

62 4 1.1732 1.1869 1.1784 1.2663

63 3 1.1273 1.1372 1.1298 1.1937

64 2 1.0831 1.0895 1.0839 1.1253

65 1 1.0407 1.0438 1.0407 1.0608

66 0 1.0000 1.0000 1.0000 1.0000

Table A: Per dollar return of different investment vehicles

Part B

Since the funds invested in the deferred annuity accumulate interest at 0.25% less than the rate on fully taxable bonds which is 5.83% (6.08%-0.25%), because of administrative costs add to this vehicle. Other things remain unchanged in part A. The per dollar return of different investment vehicles is thus different from part A.

Birthday Years to Liquidation (N) MoneyMkt Muni Annuity Keogh

51 15 1.8202 1.9016 1.8975 2.4238

52 14 1.7489 1.8218 1.8111 2.2849

53 13 1.6805 1.7454 1.7296 2.1540

54 12 1.6147 1.6722 1.6525 2.0305

55 11 1.5515 1.6021 1.5796 1.9141

56 10 1.4908 1.5349 1.5108 1.8044

57 9 1.4324 1.4705 1.4457 1.7010

58 8 1.3763 1.4088 1.3843 1.6035

59 7 1.3225 1.3497 1.3262 1.5116

60 6 1.2707 1.2931 1.2713 1.4250

61 5 1.2210 1.2389 1.2194 1.3433

62 4 1.1732 1.1869 1.1704 1.2663

63 3 1.1273 1.1372 1.1241 1.1937

64 2 1.0831 1.0895 1.0804 1.1253

65 1 1.0407 1.0438 1.0391 1.0608

66 0 1.0000 1.0000 1.0000 1.0000

Table B: Per dollar return of different vehicles (return on Annuity adjusted)

From Table B, the return of deferred annuity after adjustment is always lower than Municipal bond and it is always optimal to invest 20% of the income into Keogh account and the rest of income will invest into municipal bonds to maximize the wealth at retirement. By allocating the annual income according to this investment strategy, the total wealth accumulated on my 66th birthday will be equal to $988,129.

Part C

I assume to take a one-year unpaid sabbatical leave following my 57th birthday to retool, and will consume $60,000 on my 58th birthday. The retooling will enable me to increase myself-employment income by 20% relative to what it otherwise would have been during my remaining working years. Therefore, the annual income to be received on 59th birthday will be:

Investment Strategy Analysis

i) For the whole period between 51-66