Inflation with Savings

[lenny]

First let me say that I really have found this tool very helpful in planning my future. Great work! I've searched through the forums and I think I found the answer to my question but I have some doubt in my mind, so I figured it better to specifically ask my question.

I’m trying to understand if the values I entered in for the different savings accounts (Taxable, Tax Deferred, & Tax Free) are adjusted for inflation in the model OR if they are the “fixed” number shown on the “Summary View” (input) screen. My question in the form of an example is below:

If I have input a $10,000 deposit into a taxable savings account for 2011, does the model assume that I will deposit $10,300 in 2012 and $10,609 in 2013…assuming a 3% inflation rate OR does the model assume that I deposit a fixed $10,000 in 2011, 2012, 2013 and so on?

If the model does include the inflation rate, is there any way to “fix” the numbers (i.e. make them independent of inflation). For example, if I max out my 401K for a given year and the government doesn’t adjust the maximum contribution amount for the following year to account for inflation, I can’t possibly deposit that difference. If this discrepancy was to compound year over year, I would imagine this would create a fairly large delta between what reality is and what the model shows, right?

Any help or clarification would be greatly appreciated! Thanks!

[jimr]

If I have input a $10,000 deposit into a taxable savings account for 2011, does the model assume that I will deposit $10,300 in 2012 and $10,609 in 2013…assuming a 3% inflation rate?

Yes. That's exactly how it would work.

If the model does include the inflation rate, is there any way to “fix” the numbers (i.e. make them independent of inflation). For example, if I max out my 401K for a given year and the government doesn’t adjust the maximum contribution amount for the following year to account for inflation, I can’t possibly deposit that difference. If this discrepancy was to compound year over year, I would imagine this would create a fairly large delta between what reality is and what the model shows, right?

The delta could be large and it does sound like something you should try to adjust for. Unfortunately, while the planner supports no-cola expense cash flows, it doesn't support no-cola savings cash flows. It always assumes that savings amounts get adjusted for inflation each year.

The best way to handle this in the planner is to break the savings contributions into multiple 5-year periods and enter them into the 'additional inputs' section of the planner. With this approach, you can manually deflate the contribution amount for the start of each 5 year period in a way that the average contribution will work out about right. This is a bit of a pain, and it's obviously an approximation, but it should get you close enough.

Here's an example:

Capture.JPG (37.87 KiB) Viewed 11057 times

So in this case, you could enter a savings rate of $9409 for the first 5-yrs, then $8080 for the second, $6938 for the third, and so on. Notice that I pulled the value from roughly the mid-point of each 5-yr period. This is so on average the inflation adjusted contribution that the planner uses will about match your actual contribution.

I made a simple spreadsheet that you can edit to generate the table above using your actual numbers.

I hope that helps. Don't hesitate to ask more questions if this doesn't make sense.

Jim

[lenny]

Thanks Jim! That does help. I will try and use the spreadsheet you have posted! Thanks again!