Retirement Savings for Rookies

Last Updated Oct 11, 2011 9:37 AM EDT

I often get questions from readers and sometimes I'll answer them here. If you have questions you'd like to ask, please email me by clicking on the Contact Ray Martin link to the left.

When and how should someone in their 20s start saving for retirement in a 401(k) plan?

James C., Student, Age 20

It's great to get this question from a young person just starting out! This is exactly the right time to be thinking about and taking action on saving for retirement. The longer you wait to begin, the more you will need to save to catch's that simple.

Most younger workers fail to save for retirement. Only about 30 percent of younger workers who are eligible to join their employers 401(k) plan do so. The most common obstacles in front of retirement saving for younger folks are payments on student loans and credit card debt accumulated during college. But younger workers know that they are on their own when it comes to providing for their retirement. So starting a savings plan for retirement has to be a priority along with paying down loans and debt. Here's a plan for retirement savings for younger workers.

Join 401(k) as Soon as Eligible
The first thing to do is to sign up for your employers 401(k) plan as soon as you are allowed to do so. Most companies will require you to be employed for at least six months to a year to join the 401(k) plan. But a rising number of plans allow you to join right away. You need to know when you are eligible to join your employer's plan and sign up as soon as you are eligible. Also, find out how much you need to contribute to receive the maximum matching contributions from your employer. Most employers will require you to contribute at least six percent of your pay to get the full matching contributions.

Contribute 10 Percent
When you sign up for your employers 401(k) plan, the goal is to set your contribution rate at 10 percent. While most Employer 401(k) plans will provide matching contributions on six percent of employee contributions, don't let this give you a false sense of security that this matching formula is some implied message for what you should be contributing. An important study concluded that for the average person working and saving for retirement over 30 years - and all you will have is your 401(k) and Social security - will need to contribute a total of 13 to 15 percent of pay each and every year into a 401(k) type plan to have a reasonable chance of having enough money to pay for retirement. So, if your employer contributes three percent, and you contribute ten percent, the total contribution would be 13 percent. If contributing at 10 percent is a challenge for you, I'll provide a few tips on what to do later.

Balance Debt and Retirement Savings
Juggling debt payments and retirement savings can be a struggle. If you have student loans, do not sacrifice 401(k) plan savings to make extra principal payments on these loans. The reason is that through loan consolidation, you should be able to lock in low fixed-interest rates on these loans and therefore these may be less costly to service.

But if you have credit card debt - and most college seniors have credit card balances of $3000 to $7000 - the advice is different. Contribute an amount to the 401(k) plan to get the maximum employers matching contributions (typically six percent) and then use any extra cash flow, tax refunds, etc. to pay down your credit card balances as quickly as possible. That is because while the return on the "matched" contributions is hard to beat, the return on the "unmatched" contributions" is not likely to exceed the 18 to 29 percent interest rate you are paying in interest on the credit card debt. After you pay down your credit card debt, go back and increase your 401(k) contributions towards the target of 10 percent.

Check back tomorrow when I'll provide more retirement savings tips for young workers.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.