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Young adults, home for the holidays, are my targets for advice at this time of year. Beyond just the usual nostrums regarding taxes and the magic of compound interest, I can tailor this year's advice to the economic climate.

First, there are taxes. The average single young worker in California makes enough so that the last few dollars of income are taxed at least 25 percent. People make the mistake of taking total taxes paid and dividing by total income to estimate their "tax bracket."

It may be that you pay as low as 10 or 15 percent of your total income in taxes. For most decisions, this percentage is meaningless. As our incomes rise, the dollars falling into successive bands of income are taxed at progressively higher rates. The first dollar we make is taxed at zero. The last dollar could be taxed at 42 percent.

Most financial decisions bump taxable income up a little (a raise in pay) or down a little (like a 401(k) contribution). We may take a new job or stay put for a $200 per month raise. A raise, by definition, is the last few dollars of our income. It will be taxed at the highest percentage rate of taxes we are charged.

A 401(k) or an IRA contribution, by comparison, will be saving in taxes what would have been paid on those last few dollars. Someone with taxable income of more than $36,000 would probably be surprised to learn that their last few dollars are taxed at over 40 percent when you add up the rates for federal, state and Social Security and
Medicare taxes combined. This is why, when we deposit $100 into a 401(k), it may only cost about $65 in take-home pay. The other $35 is from the money we otherwise would have paid in taxes.

Let's face it. The job market is tough. Older people, who probably should have retired by now, are hanging on to jobs for financial reasons. This means less room at the bottom for new hires because people aren't moving up. Social Security was started back in the 1930s mainly to free up the job opportunities for young restless people rather than to provide financial support for retirees.

Early careers can be spotty. While the average employee changes jobs about seven times in a career, a good portion of those job changes take place in the early years. If you're between jobs, it is critical to have money to pay bills. So, here's where 401(k)s and IRA's come in.

You can always access old 401(k) money after you have left your employer. The best advice is to roll it over immediately into an IRA. If you need to spend some of it, you are free to do it anytime. At the end of a year, you will pay taxes on the money you spent plus a 10 percent penalty. You can probably forget about the taxes if it's in a year when you were out of work for several months.

Your lack of much earned income in that year may have dropped you down into a very low income level. In a depressing but simple example, if you were unemployed for a full calendar year, the only income you might have had was what you extracted from your rollover IRA. If this turned out to be, say $2,000 a month or $24,000 for the year, your only tax to speak of would have been the 10 percent penalty. Remember, when you take money out of an IRA, there is no Social Security or Medicare tax.

Many young people find eyes glazing over during typical 401(k) presentations that drone on about saving for retirement. "Who cares?"

If this sounds like you, you're missing the point. Money in a 401(k) is the easiest money you can possibly save. It comes right off the top of your pay before any taxes are calculated, and it is deducted automatically before you can even think about spending it. It's painless.

If you can avoid ever having to touch it, every $1,000 you contribute today will compound to $32,000 over 40 years assuming it earns market averages of 10 percent per year. Contributing $10,000 a year (costing just $6,000 in take home pay) can be $150,000 in just 10 years. BUT, sometime between now and then, money in a 401(k) amounts to your own personal unemployment insurance. It's not the end of the world if you tap the fund to pay some bills.

Timing can be important, however. If you're worked most of the year and have a good slug of taxable job income, it would pay to wait until January 1st of the following year to start tapping a 401(k) account. This would make it the first taxable money you pay yourself rather than piling it on top of what you had already earned and subjecting it to high taxes.

Working the system is not the easiest thing to figure out. Most 401(k) plans are sold by financial institutions that want you to hold onto your money under all circumstances -- even after you've rolled it into an IRA. The last thing they want you to know is what you have just read here.

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