Seth is married, files a joint return, and expects to be in the 28% marginal tax bracket for the foreseeable future. All of his income is from salary and all of it is used to maintain the household. He has a paid-up life insurance policy with a cash surrender value of $100,000. He paid $60,000 of premiums on the policy. His gain from cashing in the life insurance policy would be ordinary income. If he retains the policy, the insurance company will pay him $3,000 (3%) interest each year. Seth thinks he can earn a higher return if he cashes in the policy and invests the proceeds.

a.

What before-tax rate of return would Seth be required to earn on the proceeds from cashing in the policy to equal the return earned with the insurance company?

b.

Assume Seth estimates he can earn a 6% before-tax rate of return on the proceeds from cashing in the policy. Assume he can earn a 6% return for the remainder of his life and that he will reinvest all earnings at the same 6% before-tax rate of return. If Seth expects to live 10 more years, which alternative will yield the greater amount to his beneficiaries upon Seths death? (Given: The future value of an annuity in 10 years assuming a 4.32% after-tax return is 12.19. The future value of an annuity in 10 years assuming a 2.16% return is 11.03).