Inflation rates to expect over the next 30 years, 401k planning

Question

I am a recent college grad and now a new hire looking to choose 401k options. I am wondering what the general strategy behind choosing a 401k investment rate is. I have been reading Recent graduate with new job: Choose Roth 401(k), or traditional 401(k)?, and it looks like the Roth is the way to go.

I found a calculator to help me understand this on the fidelity page (unfortunately can't link to it as it requires a login).

The calculator is coming up with about $2k now or $10k later. Is that $10k adjusted for inflation? Because if it's not, then going to pre-tax option looks to be the better deal as 30 years at 7% inflation is a factor of 7.6x. Hence that $10k is worth about $1.3k in time of investment dollars.

I don't know anything about this stuff, so please help a newbie out :P

"401k investment rate" - are you asking how much you should save or what to project as an investment return? 7% inflation? Who is suggesting that? I am of the opinion 3% is a fair average over the long term. — JTP - Apologise to Monica, Sep 23 '13 at 23:35
Oh Really?? I always heard 7% was the standard inflation rate to expect back in highschool economics. That's what we used to do retirement calculations haha. Has it been 3% consistently? Where can I find some data on this? — SwimBikeRun, Sep 24 '13 at 00:29
Google is your friend. http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx from 1913 to 2013 the average was 3.22%. — JTP - Apologise to Monica, Sep 24 '13 at 01:00
Your question can use a bit of editing. I agree, a new grad should use Roth (first paragraph) and I am aware of multiple calculators at Fidelity (the second). But the question "$2K now or $10K later" has no background. Can you clarify exactly what you are trying to solve? — JTP - Apologise to Monica, Sep 24 '13 at 03:47
@SwimBikeRun - the 7% in highschool economics was probably to allow some quick and dirty math in a basic introduction to the topic (it make inflation standout when discussing it to use higher rates). JoeTaxpayer has correctly pointed out that actual inflation over the last century has averaged about 3.25%. There were periods of much higher inflation in that time, and periods of much lower (hence the average). — warren, Sep 24 '13 at 13:24
@JoeTaxpayer (Pedantic side note) Normally I'm more a fan of the median (2.81%) than the mean because the mean is more sensitive to higher values, but in the case of inflation, I think average is actually superior because you want a measure that's strongly affected by high positive inflation. — John Bensin, Sep 24 '13 at 16:34
Okay well the historical 3.25% means that the Roth wins my vote. Now the question is how much to invest. If there are no tax breaks or things like that, then I will just invest 15% to start with. — SwimBikeRun, Sep 24 '13 at 16:40
15% (plus any company match) should be great. From the other thread - I suggest you Roth 15%(tax rate) income, but move to pretax to avoid 25%. — JTP - Apologise to Monica, Sep 24 '13 at 16:46
yeah the company match is kind of the meat of the dish. 100% return I'll take that. @JoeTaxpayer : What do you mean by avoiding 25%? Avoiding being taxed 25% of my take home income? Is there a calculator for this? My current take home income is 70,000. At what point do I need to start putting % into pre-tax 401k? — SwimBikeRun, Sep 24 '13 at 16:57
Since you ask - http://www.joetaxpayer.com/the-15-solution/ is my excellent article addressing this subject. Note - you may already be well into the 25% bracket, and this strategy may not apply. In which case, using Roth is fine as the company match is still pretax. — JTP - Apologise to Monica, Sep 24 '13 at 17:10
Insightful article thanks. It's always hard to break into a new field. So much assumed knowledge :) — SwimBikeRun, Sep 24 '13 at 18:45
Hang around. Read some existing questions, and if you don't find what you need, feel free to ask. There's a great bunch here answering some tough questions. — JTP - Apologise to Monica, Sep 26 '13 at 02:33
@JoeTaxpayer: Given your position, "Note - you may already be well into the 25% bracket, and this strategy may not apply. In which case, using Roth is fine" doesn't make any sense. If, as you suggest in your article, you should use Traditional to defer tax on the part of the income that is in the 25% bracket, then if he is "well into the 25% bracket", it would make sense for him to put everything into Traditional, in order to defer tax on a maximal amount of 25% bracket money. Suggesting that if he's "well into the 25% bracket", then it doesn't apply, seems to be the opposite of your strategy. — user102008, Sep 26 '13 at 07:51
@user102008 - you are right. Out of context, it makes no sense. I was specifically remarking on "the 15% solution" where I advise to Roth income at 15% but go pretax to stay out of the 25% bracket. For one well into the 25% bracket at a young age, the numbers change. The pretax deposits made by the employer can put him into the 25% bracket in retirement, so saving pretax today would likely push him even higher. I should add - he might consider pre-tax as he pushes the next bracket, 28%. This comment makes assumptions that the code will be similar in 40 years. Good luck with that. — JTP - Apologise to Monica, Sep 26 '13 at 13:13

score 4 · Answer 1 · edited Sep 26 '13 at 20:48

401(k) doesn't have a "return rate", because 401(k) is not a type of investment -- it is a vehicle for investment, with certain tax treatments.

Just like your money that's not in a 401(k), you can invest it in either the bank, a CD, stocks, mutual funds, bonds, etc., you can similarly (depending on the options given to you by your 401(k) plan) invest the money in the 401(k) in a cash account, buy stocks, mutual funds, etc. Your return is dependent on how you invest your money, not whether it's in a 401(k) or not. Whether it's in a (Roth or Traditional) 401(k) simply affects when and how it gets taxed.

(It is true that most 401(k) plans offer little variety in types of investments you can choose; however, this is not a big deal, as chances are that in a few years, you will leave your company, at which point you are able to rollover the 401(k) into an IRA, at which point you will have many, many options for how to invest it.)

To make a valid comparison, you should be comparing the same type of investment in both cases. That means, you should assume the same return for both the money outside the 401(k), and the money inside the 401(k), and only consider the taxes and penalties (if you plan to withdraw early).

For more on the topic, see this article http://www.joetaxpayer.com/a-401k-is-not-an-investment/ by @JoeTaxpayer on his excellent blog. — MrChrister, Sep 26 '13 at 20:48

Inflation rates to expect over the next 30 years, 401k planning

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