Inflation, Marginal Tax Rate, Time Value of Money - Class Notes | AHRM 2304, Study notes of Financial Management

Download Inflation, Marginal Tax Rate, Time Value of Money - Class Notes | AHRM 2304 and more Study notes Financial Management in PDF only on Docsity! Chapter 1 Gross Domestic Product (GDP)- reports all economic activity (goods and services) occurred within the US. <2% is low growth >4% high Leading indicators for GDP = Rate of GDP, Employment rate, index of leading economic indicators (LEI), Consumer confidence index Inflation Personal Income- low in time of inflation Real Income- what really matters, income measured in constant prices at a base time period Nominal income (money income) - is your actual buying power, current money spent seems higher Consumer Price Index- CPI- measures inflation on a monthly index, urban households Federal Funds Rate- the rate that banks charge one another on overnight loans. Also provide and early indication of Fed policy and trends for longer-term interest rates. Marginal tax rate- the tax rate at which your last dollar earned is taxed. Income tax can sometimes be up to 25% and higher - It wills you the portion of any extra taxable earnings (from a raise, an investment, income, or money from a second job) you must pay in income taxes. - The best way to save money is to make a tax-exempt investment (state bonds) - Tax Sheltered Income-income that is exempt from income taxes in the current year grow rapidly because of compounding interest. o Investing with pretax income, tax-deferred investment growth, IRA, Roth IRA, Coverdell education savings account, qualified tuition (section 529) programs, government savings bonds (Series EE and Series I), Municipal Bonds, and capital gains on housing Time Value of Money (TVM)- a method by which one can compare cash flows across time, either Rule of 72- A formula for figuring the number of years it takes to double the principal using compound interest; simply divide the interest rate that the money will earn into the number 72. Present value- as what a future cash flow is worth today Future Value- an investment made today will be worth in the future Annuity- a stream of payments to be received in the future Employee benefit- compensation for employment that does not involve $, (paid holiday, health insurance retirement plan.) Flexible benefit Plan (Cafeteria plan)- employer gives employee choice of selecting either cash or more qualifying non taxable benefits – 2000 to spend on own personal benefits with no tax Health care plan- all medical expenses Flexible Spending Account- account that reimburses medical expenses with pretax dollars (use or lose IRS) 401-K – Tax Sheltered retirement plan, with tax deductible contributions Retirement Advantages- Tax deductible contributions, employer matching contributions, Tax deferred Growth, Starting early pays off really big Commission-only financial planners- live solely on the commissions they sell- save money on few transactions Fee-Based Planners- up front fee- advantage- unlimited consultations Fee-Offset Planners- annual or hourly fee, Adv- fee reduced as you trade investments Fee- only Planners-% no commissions and work for only fee for service basis ADV unbiased advice Chapter 2 **City Indexes- Comparing wages and cost of living for various locations Salary in City 1 x (index city 2/index city 1) = equivalent salary in city 2 Note: city indexes will be given Abilities- are the qualities that allow you to perform physically, artistically, mechanically or financially job- related tasks. Aptitudes- the natural abilities and talents that individuals possess Values- the principles, standards, or qualities that you consider desirable…basis for your goals Employment Rights- min wage, unemployment insurance, workers comp, pay social security, overtime, mat leave Chapter 3 Financial Statements: Balance sheet- snapshot in time of your assets, liabilities, and net worth on a particular date Cash-flow statement- lists and summarizes income and expense transactions that have taken place over a specific period of time, such as a month or a year. – includes income, expenses, surplus, or deficit (cash basis) Net-income: Assets – liabilities = net worth Monetary Assets- Cash, Tax Refunds, and Money owed to you by others Tangible Assets- Cars, House, Furnishings and Appliances Investment Assets-Stocks, Bonds, Life Insurance, Real Property, Annuities Insolvent- debts out-weight assets and = negative net worth Financial Ratios: 1) Basic Liquidity Ratio- How long it takes to sell of assets to pay off expenses. A high ratio is desirable >1 You want monetary assets = to 3 months expenses Equation= monetary (liquid) assets/ monthly expenses. 2) Asset-To-Debt Ratio- this compares total assets with total debt. It provides you with a broad measure of your financial liquidity. A high ratio is desirable. Equation= total assets/total debt 3) Debt Service-To-Income Ratio- this provides a view of your total debt burden by comparing the dollars spent on gross annual debt repayments (including rent and mortgage payments) with gross annual income. A ratio of 0.36 or less is desirable. Equation= annual debt repayments/gross income 4) Debt Payments-To-Disposable Income Ratio- Can I pay off my debts using surplus money. A ratio of 15% or less is desirable. Equation= monthly non mortgage debt repayments/disposable income. 5) Investment Assets-To-Total Assets Ratio- this compares the value of your investment with your net worth. This ratio reveals how well an individual or family is advancing toward their financial goals for capital accumulation. Equation= investment assets/total assets. Want as high as possible Revolving savings fund- Variable budgeting tool that places funds in savings to cover large irregular or higher- than-usual expenses 1. To accumulate funds for large irregular expenses (like a new car) 2. So you can meet occasional deficits due to income fluctuations. Subordinate Budget- 1000 vacation = 500 for car 500 for hotel KEY TOPICS Marginal Tax Rate vs. Effective Marginal Tax Rate vs. Average Tax Rate: Marginal tax rate- the single most important concept in personal finance, It wills you the portion of any extra taxable earnings (from a raise, an investment, income, or money from a second job) you must pay in income taxes. It also measures the tax reduction benefits of a tax-deductible expense that allows you to reduce your taxable income. Effective Marginal Tax Rate- the total marginal rate reflects all taxes on a person’s income, including federal, state, and local taxes as well as Social Security and Medicare taxes…to determine your own marginal tax rate on income you add all these up with your federal income tax and take that total away from your income. Difference between Deduction, Tax liability, and Tax credit: Tax Credit- Dollar-for-dollar decrease in tax liability; also known as credit Tax Credits Examples: Hope scholarship credit, Lifetime learning credit, earned income credit, child tax credit, child and dependent care credit, adoption credit, mortgage interest credit, retirement saving contribution credit, elderly or disable tax credit, and energy-savings tax credit. Tax Liability- The total amount that an individual is liable to pay to the government Tax Deductible- A variable amount subtracted from their tax income Difference between IRA, Roth IRA, Flexible Spending Accounts and 401K Individual Retirement Account (IRA)- Investment accounts that reduce current year income and that are allowed to accumulate tax free. Roth Individual Retirement Account (IRA’s)- Investments made with after-tax money; the interest on such accounts is allowed to grow tax free, and withdrawls are also tax free Flexible Spending Account (FSA)- is an employer-sponsored account that allows employee-paid expenses for medical or dependent care to be paid with an employee’s pretax dollars rather than after-tax income. Allows employees to fund qualified medical or dependent expenses on pretax basis by reducing take-home salary 401k’s- Defined-contribution plan designed for employees of private corporations; most popular retirement plan Tax Deferred vs. Tax-Sheltered: Tex deferred Income- Interest, dividends, or capital gains that are allowed to grow without taxes until distributions are taken Tax-Sheltered Income- is income that is exempt from income taxes in the current year but that will be subject to taxation in a later tax year. In addition, tax-sheltered funds grow more rapidly because compounding is enhanced when larger dollar amounts grow during the last years of an investment. Second best kind of income, because one does eventually have to pay income tax Tax-Sheltered Investments Examples: Investing with pretax income, tax-deferred investment growth, IRA, Roth IRA, Coverdell education savings account, qualified tuition (section 529) programs, government savings bonds (Series EE and Series I), Municipal Bonds, and capital gains on housing What helps reduce income tax liability? Reduce Taxable Income via Your Employer Examples: Premium-Only plan, Transportation Reimbursement Plan, Dependent Care Flexible Spending Account, and W2’s vs. W4’s: W2 form if from the employer and income is included. W4’s are where one fills out their tax deduction