karoliukas

In a tax-exempt account, contributions to the account are made with:

A) after-tax funds and reduce the investor’s current tax bill.

B) pre-tax funds and reduce the investor’s current tax bill.

C) after-tax funds and do not reduce the investor’s current tax bill.

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The tax benefit for a tax-exempt account occurs when the funds are withdrawn.

karoliukas

An investor who lives in a country with a flat tax regime is trying to decide whether to open a tax-deferred account or a tax-exempt account for retirement savings. The investor would:

A) choose a tax exempt account over a tax-deferred account if the investor thought her income would be lower after retirement.

B) be indifferent between the two accounts as long as the flat tax rate does not change.

C) choose a tax exempt account over a tax-deferred account if the investor thought her income would be higher after retirement.

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If the tax rate does not change either from a change in the investor’s income or a change in the tax law, the future value will be the same.

karoliukas

If an investment is held in a tax-exempt account, then the investor bears:

A) none of the investment risk.

B) all of the investment risk.

C) some of the investment risk.

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In a taxable account, losses realized result in a reduction in taxes that serve to offset the magnitude of the loss. Thus, some of the downside risk is transferred to the government. In a tax-exempt account, the variability of returns is not affected by the taxes.

karoliukas

If an investment is held in an account that is taxed annually, the government bears:

A) some of the investment risk.

B) none of the investment risk.

C) all of the investment risk.

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If the investment returns are taxed solely as income at the tax rate t and the pre-tax standard deviation of returns is S, then the investor’s after-tax risk is S × (1 − t), and the government bears a portion of the risk.

karoliukas

Which of the following moves by a government would most likely lead to the government taking on more investment risk?

A) Moving from a heavy dividend tax regime to a common progressive tax regime.

B) Tax regimes cannot shift investment risk.

C) Moving from a common progressive tax regime to a heavy dividend tax regime.

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Moving from a common progressive tax regime to a heavy dividend tax regime would increase the tax on dividends, which are taxed annually, and this would shift some of the investment risk to the government.

karoliukas

Gil Tabor, CFA and Jan Sills, CFA are discussing how the choice of account type affects investment risk and the amount of that risk borne by the government via taxes. Tabor says that the government bears some of the tax risk in a tax-exempt account. Sills says the government bears some of the risk in a tax-deferred account. With respect to these assertions:

A) both Tabor and Sills are incorrect.

B) both Tabor and Sills are correct.

C) Tabor is correct and Sills is incorrect.

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If the investment is held in a tax-exempt account, then the investor bears all the investment risk. This is also true for tax-deferred accounts because even though the government taxes the future accumulation, the variability of returns is not reduced by taxes levied at the time of withdrawal.

karoliukas

With respect to active investors and the tax structure in many countries, which of the following is the most accurate?

A) To offset their higher taxation, active investment managers must generate higher pre-tax returns.

B) To offset their higher taxation, active investment managers must use tax-exempt accounts.

C) As a result of their lower taxation, active investment managers can remain in business even when they generate lower pre-tax returns.

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To offset their higher taxation, active investment managers must generate higher pre-tax returns. This is also true for mutual funds, especially those with high turnover, because in many countries, long-term capital gains are taxed at a lower rate and accumulate tax-free until the gains are realized.

karoliukas

With respect to traders and active investors, which of the following statements is the most accurate?

A) Active investors trade more frequently than traders so that many of their gains are taxed at lower rates.

B) Active investors trade as frequently as traders but they use strategies that lead to their gains being taxed at higher rates.

C) Active investors trade less frequently than traders so that many of their gains are taxed at lower rates.

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Traders trade more frequently. Therefore, traders generally pay higher tax rates.

karoliukas

Of traders, active investors, and passive investors, which probably forgo the most tax advantages of equity?

A) Active investors.

B) Passive investors.

C) Traders.

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Traders trade the most frequently, and would forgo the tax-deferred properties of equity that is allowed to grow in value over a long period. Active investors trade less frequently than traders.

karoliukas

Chris Manning, CFA is advising a client concerning harvesting tax losses. The client expects that her tax situation will not change over the next few years. She asks about incurring a given loss in the current year or waiting a few years to incur the loss. She asks how the decision will affect the total taxes she pays over her life. Manning should advise her that:

A) she should not incur the loss this year because the HIFO principle means her total taxes will be higher if she incurs the loss this year.

B) she should incur the loss this year because the HIFO principle means her total taxes will be lower if she does.

C) the total tax bill over her life will not change if her tax status does not change.

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Under the indicated conditions, i.e., the tax rate not changing in the foreseeable future, the total tax burden will be the same. It is better to take losses early only to reap the gains earlier and be able to invest the gains earlier.