Finance Glossary

In the world of finance, it can feel like every other word is a supercalifragilisticexpialidocious straight out of Mary Poppins’ handbag. Rest assured we use more everyday, understandable language when working together. In case you do run into any of these terms elsewhere, however, you’ve got backup. The glossary below covers the most common financial phrases in use.
Required Minimum Distribution (RMD)

The minimum dollar amount an IRA owner must withdraw each year beginning when he or she reaches age 72, as required by the IRS.

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Fiduciary
Simply put, a fiduciary is anyone responsible for managing someone else’s money.  
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Working longer

The concept of working longer than required past retirement age in order to improve financial standing. Working longer generally has a greater impact on retirement sustainability than saving more.  According to a 2018 study by the National Bureau of Economic Research, “…working 3 to 6 extra months has an equivalent impact on the affordable sustainable standard of living as saving one percentage point more for 30 years.” For those who wait to increase savings until later in life, the power of deferring social security and working longer is significantly more impactful.

Target replacement rates

The amount of income combined with social security needed to maintain one’s standard of living in retirement. The consensus among planners is that number is 70% to 85% of pre-retirement income, according to the GAO report on Better Information on Income Replacement Rates Needed to Help Workers Plan for Retirement.

Real nominal returns

Income: 

1. Guaranteed -  social security, pensions, annuities, part-time work.

2. Personal savings – 401(k)s, IRAs, Roths, non-retirement investment accounts, reverse mortgage

Immediate Annuity

An insurance product that provides a guaranteed stream of income for life or a set number of years that is purchased with a one-time payment.

Deferred Annuity

An investment account, sold by insurance companies, which grows tax-deferred until funds are withdrawn

Defined Benefit Pension Plan

A company-sponsored retirement plan that provides a guaranteed monthly income based on the age at retirement and the number of years of employment.

Defined Contribution Plan

A retirement plan, such as a 401(k), that is funded by employer contributions as well as with employer matching contributions.

IRA

An individual retirement account is a one-person retirement account in which contributions are generally tax-deductible and distributions are taxable as ordinary income.

Early Withdrawal Penalty

A 10% additional tax on distributions from retirement accounts before age 59 ½.

401(k)

A 401(k) is the most popular employer-sponsored retirement savings plan. With a traditional 401(k), you contribute a portion of each paycheck to the plan, pick your investments and don’t pay taxes on the contributions or earnings until you start taking withdrawals. As of 2021, 401(k) contribution limits are $19,500 per year, or $26,000 if you’re 50 or older.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Matching Contributions

Matching contributions are incentives from your employer to encourage you to actively save for retirement. If an employer makes contributions to your 401(k), they generally match a portion of the contributions you’re depositing in the account each month, up to a set percentage of your total salary.


For example, an employer may match 100% of your contributions, up to 3% of your salary. If you earned $50,000 per year, that means your employer would match up to $1,500 of your 401(k) contributions. There is no set formula, so be sure to check with your company.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Annuities

An annuity is a contract you make with an insurance company or financial services firm. In exchange for one or several contributions in the present, the company agrees to provide future income (usually with some amount of interest) for a set number of years—or the rest of your life. Because of the certainty they offer, annuities are a popular option for people who want to receive reliable income in retirement when they no longer earn a salary.


Annuities come in many forms, including fixed annuities, variable annuities, immediate annuities and index annuities. Their contracts and fees can be very complex, so make sure to get a financial professional’s input on any potential purchases.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Defined Benefit Plan

Defined benefit plans are employer-sponsored retirement plans that provide workers with guaranteed monthly income in retirement. The most common type of defined benefit plan is a pension.


Due to their high costs and the level of risk assumed by employers when funding and managing investments, defined benefit plans are increasingly rare. Pensions have been widely replaced by 401(k) plans.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Exchange-Traded Funds

Exchange-traded funds, commonly called ETFs, are an investment that pools your money in a fund with other investors to buy a diversified mix of investments. ETFs aim to duplicate the performance of underlying stock and bond indexes, like the S&P 500. ETFs aren’t generally offered in 401(k)s, but you can invest in ETFs if you have an IRA or taxable investment account.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Mutual Funds

Similar to ETFs, mutual funds pool money from many investors to purchase a broad range of stocks, bonds or short-term debt. Mutual funds provide instant diversification, since you’re buying a basket of securities rather than investing in a single company.


Mutual funds are commonly actively managed, meaning a team of experts selects and trades securities to try and provide positive returns. Index funds are mutual funds that aim to duplicate the performance of major market indices are increasingly popular because of the low costs but solid returns they provide.


You can purchase shares of index funds and mutual funds in a 401(k), IRA or taxable investment account.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Roth 401(k)

This type of 401(k) offers special tax advantages. Unlike traditional 401(k) accounts, where you make contributions on a pre-tax basis, Roth 401(k) contributions are made with money you’ve already paid taxes on. Because there is no upfront tax deduction, your earnings and withdrawals are tax free once you reach 59 ½.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

SEP IRA

A Simplified Employee Pension (SEP) IRA is a retirement plan for self-employed individuals, freelancers and small business owners. Employers (or a self-employed person acting as their own employer) are typically the only contributors, and they can contribute up to 25% of the employee’s total compensation or $58,000 for 2021, whichever is less.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement plan generally offered by small employers and new businesses that don’t have the time or resources to administer a 401(k). Employers generally are required to contribute 2% of an employee’s salary, regardless of if they contribute themselves, or to match employee contributions dollar-for-dollar, up to 3% of their salary. Employees can contribute up to $13,500 per year ($16,500 for those 50 or older) in 2021.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Social Security

Social Security is a pension program primarily for retirees and their families managed by the federal government. It replaces a portion of your wages based on your highest 35 years of earnings and when you decide to start receiving benefit payments.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Solo 401(k)

As the name implies, a Solo 401(k) plan is a 401(k) plan for self-employed individuals and business owners who don’t have employees other than their spouses. Depending on your income, a Solo 401(k) may allow you to contribute more than a SEP IRA. Solo 401(k)s are also available as Roth accounts, which gives them another edge over SEP IRAs for the self-employed.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Target Date Fund

A target date fund is a professionally managed portfolio held in a mutual fund that adjusts its holdings based on the year you want to retire. When you’re young, a target date fund invests aggressively, primarily in stock-based funds. As you get older, the fund gradually becomes more conservative, introducing more bond- and fixed-income-based funds. Like robo-advisors, target date funds are well suited to those who want hands-off, set-it-and-forget-it retirement investing.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Vesting

Vesting has nothing to do with outerwear. Instead, vesting generally refers to the amount of ownership you’ve built up over something, like your employer’s contributions to your workplace retirement account.


To encourage you to stay long term, an employer might set up a vesting schedule that grants you increasing ownership over your 401(k) match each year. For example, you might earn 20% of your employer match each year you work at your company until you own all of it outright after five years. If you leave before you’ve reached the end of your vesting period, you forfeit any contributions you haven’t earned.


SOURCE: Forbes Advisor, 20 Retirement Terms You Should Know

Adjusted Gross Income

An interim calculation used in computing income tax liability. It is computed by subtracting certain allowable adjustments from gross income.

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Asset Allocation

The process of determining how investment funds will be apportioned among different asset classes, such as stocks, bonds, and cash reserves. Many financial advisers believe that the mix of asset classes has a greater impact on long-term portfolio results than does the performance of any individual investment.

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Compounding

Earning money on a principal investment and its interest, usually calculated on a monthly or yearly basis. Compounding is said to be one of the best ways to create wealth.

Coverdell Education Savings Account: A type of account (previously called the Education IRA) created under the Taxpayer Relief Act of 1997, established exclusively for paying qualified education expenses of the designated beneficiary. Contributions are non-deductible and earnings are tax-free for qualified withdrawals.

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Coverdell Education Savings Account

A type of account (previously called the Education IRA) created under the Taxpayer Relief Act of 1997, established exclusively for paying qualified education expenses of the designated beneficiary. Contributions are non-deductible and earnings are tax-free for qualified withdrawals.

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Death Distribution

The payment of IRA funds to a beneficiary upon the death of an IRA owner.

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Deduction

Expense allowed by the Internal Revenue Service to be subtracted from an individual's gross income before figuring a person's taxable income. Certain Traditional IRA contributions are classified as a tax deduction.

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Direct Rollover

The movement of funds from a qualified retirement plan into an IRA without the account owner taking receipt of the funds.

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Distribution

Withdrawing funds from a retirement savings plan.

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Diversification

Strategy for reducing the risk of investing in a single industry/market sector or a small number of companies, by spreading the risk over several industries/market sectors or a larger number of companies.

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Dollar Cost Averaging

A method of accumulating assets by investing a fixed amount of dollars in securities at set intervals, regardless of stock market movements.

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Early (premature) Withdrawal

A withdrawal of funds from an IRA, a 401(k) plan, or any tax qualified retirement plan, usually before age 59½. Early withdrawals are subject to tax penalties, though there are some exceptions.

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Earned Income Rule

Rule regarding eligibility to contribute to certain types of IRAs. For a Traditional or Roth IRA, an individual must have earned income to contribute. Earned income includes but is not limited to wages, salaries, bonuses, tips, commissions and taxable alimony.

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Education IRA

See Coverdell Education Savings Account.

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Employer-sponsored Retirement Plan

A Defined Contribution or Defined Benefit retirement plan. The most common types are 401(k), Profit Sharing Plans and Pension Plans. Other types include SEP, Keogh and SIMPLE plans.

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Excess Contribution

Any IRA contribution that exceeds the maximum contribution limits permitted by law. Penalty taxes apply for each year an excess contribution exists.

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FDIC

The Federal Deposit Insurance Corporation is an independent agency created by the Congress to maintain stability and public confidence in the nation's financial system by: insuring deposits, examining and supervising financial institutions for safety and soundness and consumer protection, managing receiverships.

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Form 5329

The IRS tax form on which early (premature) withdrawals are reported.

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Form 8606

The IRS tax form on which non-deductible IRA contributions are reported.

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Individual Retirement Account (IRA)

A tax-deferred retirement plan that an individual with earned income can open. Some individuals may deduct their IRA contributions from their taxable income.

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Inflation Risk

The risk that the purchasing power of your investment will be eroded by inflation. Because more conservative investments generally provide the lowest returns over time, they are generally more exposed to possible inflation risk.

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IRA Transfer

The movement of IRA funds directly from one IRA provider to another without the IRA owner taking receipt of the funds. This transaction is sometimes referred to as a Trustee to Trustee transfer.

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Life Expectancy

The average number of years an individual is expected to live based upon his or her current age. Life expectancy tables provided by the IRS are used in calculating Required Minimum Distributions and Substantially Equal Periodic Payments for IRA distributions.

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Lump Sum Distribution

Payment to a recipient of all funds accumulated in a 401(k) account or other tax-qualified plan within one taxable year.

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Qualified Retirement Plan

A Defined Benefit or Defined Contribution retirement plan that receives special tax treatment because it meets the requirements of the Internal Revenue Code.

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Required Beginning Date (RBD)

The deadline by which an IRA owner must take his or her first Required Minimum Distribution. The RBD is April 1 after the year in which the IRA owner turns age 72.

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Rollover

A tax-free movement of funds from one tax-qualified plan to another or to an IRA. The requirements for a rollover depend on the type of program from which the distribution is made and the type of program receiving the distribution.

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Rollover IRA

An IRA established to hold the assets of an eligible distribution from a qualified plan.

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Roth IRA

A type of IRA established under the Taxpayer Relief Act of 1997. The Roth IRA is sometimes referred to as the 'back-ended' IRA since contributions are not tax-deductible, but the earnings may be withdrawn tax-free if IRS guidelines are met.

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Roth IRA Conversion

The distribution of assets from a Traditional IRA into a Roth IRA.

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Recharacterization

The reversal of a Roth IRA conversion or the redesignation of funds between plan types.

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Self-directed IRA

An IRA that allows the individual to select the investment options that best fit their investment objectives. The investment choices include stocks, bonds, mutual funds and other funds and other investment vehicles, Certificate of Deposits and other savings vehicles.

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Simplified Employee Pension Plan (SEP)

An employer-sponsored retirement plan that is designed for owners of small businesses or self-employed individuals. Contributions are tax-deductible and earnings tax-deferred. Qualified individuals can contribute a fixed percentage of their earned net income (up to $49,000 maximum for 2011). SEPs are more flexible, easier to set up, and simpler to administer than many other qualified plans.

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Substantially Equal Periodic Payments

A type of distribution from an IRA that may begin, without penalty, prior to age 59½. Substantially equal payments are calculated over the IRA owner's life expectancy.

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Tax-Deferred

The postponement of taxes and sometimes the initial investment, until the funds are distributed.

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Traditional IRA

Original IRA designed to encourage individuals to save for retirement. The three benefits of a Traditional IRA are tax deferral of interest/earnings, potential tax deferral of contributions and assurance for a more financially secure retirement.

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Vested

For a retirement savings plan participant, vesting refers to the gradual granting of ownership of contributions made by your employer.

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