September 16, 1998

Which comes first: 401(k) or loans?

By EILEEN GLANTON
AP Business Writer

Q: I've graduated from college and started a great new job. Should I put part of my paycheck into the company-sponsored 401(k) plan or repay school debts first?

A: Flash back to those multiple-choice tests you thought you left behind: The best answer is "all of the above."

In 1996, the average public-college graduate left school with $11,950 in student-loan debt. Add in the costs of life after college -- professional clothes, rent, car payments -- and saving money may seem an impossible goal.

Thinking about a 401(k) -- a retirement savings plan -- may seem somewhat premature. But here's why you shouldn't delay:

If you save $1,000 a year from the time you're 25 to the time you're 34, and your account earns 8 percent annually, you'll have $168,627 by the time you're 65. That's without any added investment after age 34.

But if you start when you're 35, saving that same $1,000 each year for 30 years, you'll only have $125,228 when you're 65.

"Time is gone and it's gone forever," says Maureen Tsu, a certified financial planner in San Juan Capistrano, Calif.

Clearly, it pays to start saving now, and the 401(k) is an easy way to do it.

A 401(k) plan allows an employee to contribute earnings to a company pool. The money is invested in a mix of mutual funds and only taxed if you withdraw it. Contributions don't count toward your "taxable base," so you may end up owing less to the Internal Revenue Service.

Even better, most companies match at least some of their employees' contributions.

"This is free money," says Tsu. "If your employer offers you a match, you should take advantage of the plan as soon as you can."

You can save up to $10,000 per year in a 401(k) plan. When you're just starting out, you may choose to save less. But a good rule of thumb is to save at least as much as your employer will match, Tsu says.

"If they'll give you a match on the first 3 percent, save 3 percent," she said. If you're making $27,000 a year, that's $810 a year, or $15.58 a week. That's less than dinner and a movie.

Now, that doesn't mean you can ditch the student loans. Paying bills on time shows lenders you're a good credit risk.

Because they have low interest rates, student loans are "an extraordinarily cheap source of credit," says Robert Jackson, vice president of product management at the Student Loan Marketing Association, or Sallie Mae. So while you must make regular payments, you shouldn't feel compelled to pay off a student loan in one lump sum.

Instead, chip away at your higher-interest loans, like credit card bills. And get used to spending a little bit less as you're building that 401(k). Rent some movies. Cook some pasta. And watch your savings grow.