Problem
Jessica is married, files a joint return, and expects to be in the 24% marginal tax bracket for the foreseeable future. All of her income is from her salary and all of it is used to maintain the household. She has a paid-up life insurance policy with a cash surrender value of $100,000. She paid $60,000 of premiums on the policy. Her gain from cashing in the life insurance policy would be ordinary income. If she retains her policy, the insurance company will pay her at least $3,000 (3%) interest each year. Jessica thinks she can earn a higher return if she cashes in the policy and invests the proceeds.
A. What before-tac rate of return would Jessica be required to earn on the proceeds from cashing in the policy to equal the return earned with the insurance company?
B. Assume Jessica estimates she can learn 6% before tax rate of return on the proceeds from cashing in the policy. Assume she can earn a 6% return for the remainder of her life and that she will reinvest all earnings at the same 6% before tax rate of return. If Jessica expects to live 10 more years, which alternative will yield the greater amount to her beneficiaries upon her death? (Given: The future value of an annuity in 10 years assuming a 4.56% after-tax return is 12.19. The future value of an annuity in 10 years assuming a 2.16% return is 11.03)