Chapter 16
Questions and Problems 1. Suppose that Helen’s marginal income tax rate is 28
percent. Compare her after-tax income and her group medical costs under three
scenarios: (a) She receives $45,000 in salary and pays $2,500 for individual medical
coverage, (b) she receives $43,000 in salary and group medical coverage on a non-
contributory basis with the employer’s contribution to the cost of coverage equal to
$2,500, and (c) she receives $46,000 in salary and group medical coverage on a
contributory basis with the employer’s contribution equal to $1,250 and her required
(tax-deductible) contribution equal to $1,250. What would the difference be between
(a) and the other two scenarios if individual insurance costs Helen $2,700 due to a
higher expense loading?
a. After-tax income = $45,000 * (1 - 0.28) = $32,400
$32,400 - $2,500 = $29,900
b. After-tax income = $43,000 * (1 - 0.28) = $30,960
No additional costs for Helen.
c. After-tax income = (46,000 – 1,250) * (1 – 0.28) = $32,220
$32,220 - $1,250 = $30,970
After-tax income: a. $29,900 b. $30,960 c. $32,220
Therefore, according to comparing the after-tax income, scenario c will have the
highest after-tax income with medical insurance.
If insurance costs Helen $2,700:
a. After-tax income = $45,000 * (1 – 0.28) = $32,400
$32,400 - $2,700 = $29,700
b. After-tax income = $43,000 * (1 – 0.28) = $30,960
c. After-tax income = $46,000 * (1 - 0.38) = $33,120
$33,120 - $1,350 = $31,770
The difference between a and b: $30,960 - $29,700 = $1,260
The difference between a and c: $31,770 - $29,700 = $2,070
Therefore, if the insurance costs increase, then the after-tax income of scenario b
remains but that of scenario a and c decreases by $200.
Chapter 17
Questions and Problems 6: A complicating feature of the tax code is that interest and
dividends are taxed at a higher rate than capital gains for individuals. A lower capital
gains tax rate reduces the desirability of investing in assets with high expected capital
gains within a tax-deferred account. The reason is that in a tax-deferred account
investment earnings are taxed at the ordinary income tax rate even if some of the
earnings are from capital gains. Thus, when deciding to save through an account with
tax-deferred earnings, one must compare the advantage of deferring tax versus the
disadvantage of potentially paying a higher tax rate on some of the earnings. To
illustrate, suppose that Travis is going to retire in 10 years, the annual before-tax rate
of return is 10 percent, one-half of this return is from capital gains, his income tax rate
is 30 percent, and his capital gains tax rate is 20 percent. Will Travis have more
money at retirement by saving $1,000 of before-tax wages in a qualified account or
will he have more money by saving in an account with no tax benefits?
A. $1,000 * (1 + 0.1) ^10 = $2,593.74
After-tax amount = $2,593.74 * (1 – 0.3) = $1,815.62
B. Capital gains = 0.1 * 0.5 = 0.05
After-tax capital gains rate = 0.05 * (1-0.2) = 0.04
Income rate of return = 0.1*0.5 = 0.05
After-tax income rate = 0.05 * (1-0.3) = 0.035
0.035 + 0.04 = 0.075
After-tax amount = $1000 * (1 + 0.075) ^10 = $2,061.03
Tax-deferred account: $1,815.62
Non-tax-deferred account: $2,061.03
To sum up, Travis will have more money by saving $1,000 in an account with no tax
benefits.
Disability income insurance
7. Do you think it is fair to have a more restrictive definition of total disability for
sickness in a disability income policy than for disability caused by an accident? After
all, if you are disabled and can’t work, you need income replacement regardless of the
cause of your disability. Please explain.
In my point of view, it is not fair to be more restrictive to total disability for
sickness compared with disability caused by an accident.
For example, from the policyholder’s perspective, they need income replacement
no matter what caused their disability because they couldn’t work anymore. If the
total disability for sickness has more restrictive definitions, it would be trouble and
hard to afford to live for people who are disabled due to sickness because the process
of distinguishing the specific categories and getting the claim costs is going to take a
long way to go. Thus, I don’t think it is fair for all people, because no matter what
caused them disabled, the result is that they couldn’t work anymore but they have to
live.
Chapter 19
Questions and Problems 2: Using the payroll tax rates discussed in the text and the
maximum taxable wage base for 2003 of $87,000, calculate the payroll tax (OASDI
and HI combined) that would be paid by the employee and the employer for each of
the following amounts of annual wages: (a) $20,000; (b) $35,000; (c) $50,000; (d)
$100,000; and (e) $150,000.
a. $20,000:
Employee: $20,000 * (0.062+0.0145) = $1,530
Total tax (Employee + Employer): $3,060
b. $35,000
Employee: $35,000 * 0.0765 = $2,677.5
Total tax (Employee + Employer): $5,355
c. $50,000
Employee: $50,000 * 0.0765 = $3,825
Total tax (Employee + Employer): $7,650
d. $100,000
Employee: $87,000 * 0.0765 + $13,000 * 0.0145 = $6,844
Total tax (Employee + Employer): $13,688
e. $150,000
Employee: $87,000 * 0.0765 + $63,000 * 0.0145 = $7,569
Total tax (Employee + Employer): $15,138
The employer would match the amounts calculated above.
Long-Term Care Insurance
Why has there been growing interest in long-term care insurance?
First of all, long-term care is really important for aging people and people who
are disabled or have chronic diseases that need nursing home care for a long time,
however, long-term care is very expensive, and the average cost of a nursing home in
2013 was up to $90,000 per year. Additionally, most long-term care policies have
been issued as qualified policies.