Millennials and retirement: unlike our parents, we're on our own

Memo to all millennials: We are responsible for our own retirement. Our parents had a pension and Social Security to help them in their golden years. Our financial future will be more complex and self-directed.

Pensions have proven to be unsustainable and are quickly becoming a thing of the past. Although we are paying into Social Security with every paycheck, chances are slim that we will reap much benefit when it’s time for us to retire. The most the average millennial can really hope for in terms of corporate or government-provided retirement benefits is a 401(k) plan with an employer match.

All is not lost, however. It is possible to save enough for retirement simply by starting early and investing your money wisely.

The first step is starting now. The earlier you start, the less you’ll need to save on an annual basis. I generally recommend that people who are in their 20s should save at least 15% of their gross income. Starting later means an even larger annual savings percentage is required to meet retirement goals.

The second step is investing wisely. If you leave money sitting in cash, it loses about 2% to 3% per year due to inflation. So if you have $10,000 in cash, it will be worth $9,700 after one year and $9,409 after two years. That is a $591 loss in purchasing power in two years, which will grow larger each year your nest egg sits in cash.

The annualized return of the S&P 500 over the last 25 years is close to 10%, which shows how investing will serve you much better. I recommend that young people diversify broadly and be patient. You are in this for the long term. If your investments are diversified, there is no need for trading with the ebbs and flows of the market.

Massive student loan debt is one more obstacle to retirement saving for millennials. Our parents’ generation did not have to shoulder the same financial burden. The question of whether to save for retirement or pay off student loans first generally comes down to two issues: your attitude toward debt and the interest rate you are paying on the loans.

If having debt keeps you up at night, then throw every dollar you would otherwise save toward the loans, regardless of the interest rate. If you are more comfortable with debt, then the decision comes down to the interest rate. If you are paying a high interest rate on your student loans, you should try to refinance.

Also, you are probably better off throwing every dollar you have toward the loan because there is no guarantee you can get a better return in the stock market compared with the interest you are being charged on the debt. If your loans have a low interest rate, then investing excess funds in a retirement account is a good idea.

Once you start saving for retirement, your funding priority should be:

Employer-sponsored retirement plan

If your company provides a match, it’s crazy not to contribute enough to capture the entire match. It’s free money! Plus, these plans are tax-deferred so they lower your tax bill. Another bonus is that the entire amount is protected from creditors under federal law.

Maximum salary deferral into these plans is $18,000 for 2015. If you are a millennial and you are maxing out your 401(k), give yourself a pat on the back. You are way ahead of the curve.

Keep in mind that the money you put into these accounts is for the long-term. Accordingly, you will have to pay taxes and a penalty if you withdraw these funds before age 59.5.

Roth IRA or traditional IRA

If you can contribute to a Roth IRA, I highly recommend it. I like to look at Roth IRAs as savings accounts with superior investment options. That’s because they are funded after tax (so you can withdraw your funds tax-free) and there are few restrictions on withdrawing the money you contribute. However, there are income limits.

If you make too much to contribute to a Roth IRA, then you may be able to contribute to a traditional IRA. Like most employer-sponsored retirement plans, these are pre-tax and carry penalties for early withdrawal.

If you contribute the maximum to both your employer-sponsored plan and a Roth or traditional IRA, and you still have money left over, then an after-tax investment account is a great place for those funds to grow.

Learn more about Rachel on NerdWallet’s Ask an Advisor.