The world of retirement - and financial services - can be difficult to navigate. PensionBee wants you to be retirement confident so we created a dictionary of common financial and retirement terms so you can start taking control of your future retirement.
401(k) Plan
A 401(k) plan is an employer-sponsored retirement savings plan that enables employees to contribute a percentage of their income to a tax-advantaged investment account. This defined contribution plan allows employers to match a portion of their employee contributions, making it a valuable investment tool for successful retirement planning.
403(b) Plan
A 403(b) tax-advantaged retirement savings plan is offered to employees of public schools, certain 501(c)(3) tax-exempt organizations, and some government agencies. It allows participants to contribute pre-tax dollars through their payroll deductions with potential employer-matching contributions. It's similar to a 401(k) but it's designed for different types of employers and sometimes comes with different investment options and rules.
Accrued Benefit
An accrued benefit is the amount an employee has accumulated over a set period of time, usually based on the number of years of service and their salary. In a defined benefit plan, the accrued benefit is expressed as an annual benefit that begins at normal retirement age.
Annuity
A financial contract between an individual and an insurance company designed to provide regular, guaranteed income over a specific period (or for the rest of the individual's life). The individual pays either a lump-sum amount of money or a series of smaller payments to the company which invests the funds and then returns them as disbursements at a set time in the future. Annuities are commonly used in retirement planning to ensure a steady income stream during those post-employment years.
Annuity Contract
A legal agreement between an individual and an insurance company under which the terms of the annuity are outlined, as well as the type of annuity (fixed, indexed, or variable), the payment schedule, penalties for early withdrawal, and information regarding beneficiaries and death benefits.
Annual Contribution Limit
An individual's annual contribution limit is the maximum amount that they can contribute to a retirement savings account each year. The limit applies to all contributions made by both the employer and employee for plans such as 401(k) and 403(b) as well as other qualified retirement plans and is set by the Internal Revenue Service (IRS). The IRS adjusts the limits of various plan types each year for inflation.
Asset Allocation
Asset allocation is the process of dividing an investment portfolio across different asset classes such as stock market equities, bonds, mutual funds, real estate, and cash to balance risk and potential returns. The goal is to optimize the portfolio's financial performance, reduce overall risk and liability, and increase the odds of hitting investment targets.
Beneficiary
A person or entity designated to receive any benefits or remaining assets from a financial account, retirement plan, or insurance policy when the account holder dies. Beneficiaries can be individuals, estates, trusts, or charities. PensionBee helps make assigning a beneficiary easy.
Capital Gain
A capital gain is the profit earned from the sale of a capital asset. This could relate to stocks, bonds, real estate, or other investments when the sale price exceeds the original purchase price. In other words, if you make a profit on an asset, it's considered a capital gain.
Catch-Up Contribution
Individuals who are 50 or older can contribute additional amounts beyond the standard annual contribution limits. These extra amounts are called catch-up contributions, and the IRS updates the allowable amounts each year to adjust for inflation. They can be made toward various retirement accounts including 401(k)s, 403(b)s, traditional IRAs, Roth IRAs, and SIMPLE IRAs.
Certificates of Deposit (CDs)
A type of savings account offered by banks, credit unions, and other financial institutions. CDs offer fixed terms, fixed interest rates, and usually require a specific principal amount that is deposited when the CD is opened. If the owner of the account withdraws the money before it matures, there may be a penalty.
Compound Interest
Compound interest is earned on both the initial principal amount and the accumulated interest from previous periods. For example, say you have an investment with a favorable interest rate. The interest you accrue each period raises the account balance of your investment so that you'll earn interest on a higher dollar amount during the next period (which means more interest earned), and so on, and so forth. Compound interest is perhaps one of the most powerful wealth-building investment vehicles available to investors as it enables exponential growth.
Defined Benefit Plan
A defined benefit plan is a type of employer-sponsored retirement plan that promises a specific amount to employees when they retire. The amount is based on a predetermined formula that typically considers the employee's salary history, years of service, and age. The employer is responsible for managing the plan's investments and taking on the investment risk, and disbursements are either paid as annuity or lump-sum payments.
Defined Contribution Plan
A defined contribution plan is an employer-sponsored retirement plan where contributions are made by either the employer, the employee, or both, and the benefits are based on the amounts contributed to individual accounts as well as any investment earnings. Contributions are made using pre-tax dollars which reduce the employee's taxable income and the funds grow tax-deferred until withdrawal. Some plans also include Roth contributions which provide tax-free withdrawals when conditions are met.
Defined Contribution Plan Administrator
A person or entity responsible for managing the operations of a defined contribution plan such as a 401(k). The administrator makes sure that contributions are collected and allocated properly and that compliance standards and regulations are met. They don't make investment decisions directly but they are responsible for making sure that the plan's assets are invested correctly.
Disability Withdrawal
Withdrawing from a retirement account such as a 401(k) or IRA early (before the age of 59½) normally means an individual will pay a 10% penalty, but a disability withdrawal provides an exception to the rule if certain conditions are met. The IRS stipulates that the individual must be completely disabled on a permanent basis and unable to seek gainful employment because of a mental or physical impairment in order to satisfy the criteria.
Diversification
A highly useful risk management strategy used in investing to reduce the overall risk of a portfolio by spreading investments across numerous asset classes, industries, and even geographic regions. This could mean stocks, bonds, mutual funds, commodities, cryptocurrencies, and other investments, but the primary objective is to not have all your eggs in one basket, so to speak.
Dividend
A dividend refers to the distribution of funds or assets from a portion of a company's earnings to its shareholders. Dividends come out of the company's net profits and are distributed either in cash by electronic transfer or check or awarded in the form of stock dividends, property dividends, or other special dividends at the discretion of the board of directors.
Dollar-Cost Averaging (DCA)
Dollar-cost averaging is an investment strategy that involves investing a fixed amount of money at regular intervals regardless of the price of the asset at the time of investment. This means investors end up purchasing more shares when prices are low and fewer shares when prices are high in an effort to reduce the impact of market volatility.
Drawdown
Drawdown refers to the decline in the value of a given investment, trading account, or fund. It's measured from peak to trough (highest point to lowest point) during a set period. Drawdown is typically expressed as a percentage that represents the difference between the high and the low. An investment that rises to $10,000 before falling to $7,000, for example, would have experienced a 30% drawdown. Paying attention to drawdown can help you eliminate risk as it's a good indicator of the potential losses you may experience before your investment recovers.
Drawdown Percentage
Drawdown percentage (known as withdrawal rate in the US) refers to the amount you draw from your retirement fund each year. This is a crucial metric as it can help you determine how much you can safely spend each year without running the risk of depleting your savings too early. The common rule of thumb is the "4% rule" which states that you can withdraw 4% of your total retirement savings each year in order to maintain a sustainable income. If you withdraw too much you may face difficulties as you age, whereas if you don't withdraw enough, there may be a surplus of cash when you die.
Early Withdrawal Penalty
A fee (often 10%), payable by those who withdraw funds from certain retirement accounts such as 401(k)s or IRAs before they reach the age of 59½. Early withdrawal penalties are in addition to the regular income taxes that would be owed on the distribution and serve to discourage premature access to retirement savings. That said, there are some exceptions to paying early withdrawal penalties, such as in the case of financial hardship or disability.
Employer Matching Contributions
Contributions made by an employer to an employee's retirement savings plan such as a 401(k) based on the amount the employee contributes. Employer contributions often match a percentage of the employee's contributions up to a certain limit, such as matching 50% of contributions up to a set percentage of the employee's salary or dollar-per-dollar matching with a cap.
Employer-Sponsored Plan
An employer-sponsored plan is a benefit plan provided to employees that aids in saving for retirement. These plans are funded through deductions from the employee's paycheck as well as from funds contributed or matched by the employer. In the case of 401(k)s, contributions are made to the plan with pre-tax dollars, meaning employees can lower their taxable income. Employer-sponsored plans act as a solid starting point in long-term financial planning strategies.
Employee Retirement Income Security Act (ERISA)
ERISA is a federal law enacted in 1974 by the federal government that sets minimum standards for pension plans and health plans in the private sector. Its focus is to protect the interests of benefit plan participants and their beneficiaries by establishing requirements for the disclosure of financial information, imposing fiduciary duties on anyone who manages and controls plan assets, and insuring certain pension benefits, among other things.
Fiduciary
A fiduciary is an individual or entity that holds a legal or ethical relationship of trust with another party. This relationship typically involves the management of either money or assets on behalf of the other party which is governed by a responsibility to act in their best interests. Fiduciaries are legally and ethically bound to uphold certain duties including loyalty, care, and disclosure, and they can assume the roles of trustees, financial advisors, executors, or corporate officers.
Financial Advisor
A financial advisor is a licensed professional who advises individuals and families on their financial decisions, investment strategies, tax strategies, budgeting, debt management, and long-term planning strategies such as retirement planning or estate planning. Advisors can be Certified Financial Planners (CFPs), wealth managers, Registered Investment Advisors (RIAs), or insurance agents.
Financial Institution
Financial institutions are business entities that provide a range of different financial services. They may be categorized into depository institutions such as banks and credit unions (places that deal with everyday banking needs), or non-depository institutions such as insurance companies and investment firms. Either way, financial institutions facilitate banking activities such as taking deposits, issuing loans, managing investments, and connecting people who have capital with people who need funds—which perpetuates economic growth.
Hardship Withdrawal
A way you can withdraw funds from your 401(k) or IRA without the usual penalties, provided you are facing what the IRS deems "immediate and heavy financial need." This type of withdrawal can only be made for certain expenses, namely medical bills, the purchase of a primary home, educational expenses, or expenses related to the prevention of eviction or foreclosure. The standard 10% penalty for those under 59½ is waived in these circumstances. You do need to know that the amount you withdraw will be subject to regular income taxes.
In-Service Withdrawal
A provision that allows an employee to take distributions from their employer-sponsored retirement plan—such as a 401(k)---while still employed. This can be helpful in cases of financial hardship or to give an advantage to one's personal investment strategy. There are usually a few rules outlined in the plan's documents that may allow for these distributions if certain conditions are met. There may also be tax implications to consider which could affect long-term retirement savings as the funds cannot be repaid to the account.
Individual Retirement Account (IRA)
A retirement savings account that provides tax advantages to encourage and incentivize people to save diligently for their retirement. There are traditional IRAs, Roth IRAs, Rollover IRAs, SEP IRAs, and SIMPLE IRAs, each with its own set of features and tax benefits, though the key selling feature is tax-advantaged growth, a range of investment options, and the ability to supplement existing employer-sponsored retirement plans.
Inflation Risk
Also known as purchasing power risk, inflation risk refers to the potential loss of purchasing power that occurs when the price of goods and services rises faster than anticipated. This occurance diminishes the true value of money over time so that the same amount today will be worth less in the future. Inflation risk is an important consideration for fixed-income investments as the purchasing power could decline leaving you with less value in your pocket than you had planned for.
Investment Advisor
A financial professional who offers investment advice to help clients navigate various financial situations, identify their investment goals, and uncover their risk tolerance so that tailored investment strategies can be developed and maintained. They may be responsible for assessing their clients' financial goals, timelines, and risk profiles, selecting appropriate investments such as stocks, bonds, mutual funds, and ETFs, monitoring client investment portfolios, and complying with various laws and regulations. At the end of the day, advisors have a fiduciary duty to always act in the best interest of their clients.
Investment Options
The range of financial assets that you can choose to invest in with the goal of generating a financial return. There are various asset classes such as stocks, bonds, mutual funds, real estate, ETFs, commodities, cryptocurrencies, and more, each with its own risk and return profile. When choosing what to invest in, you should be sure to consider your risk tolerance, specific investment goals, time horizon, whether you wish to diversify (it's highly advisable that you do), and the liquidity of the asset in question (how easy it is to convert it back into cash).
Investment Portfolio
A collection of financial assets and securities that are designed to achieve specific financial goals while managing and mitigating risk. A strong portfolio contains a diverse range of assets so that risk on any one investment is minimized. You can adopt various strategies to manage your portfolio:
- Income-focused, which prioritizes cash flow from interest or dividends
- Growth-focused, aimed at capital appreciation through higher-risk investments
- Value-focused, which specifically targets undervalued assets
Investment Risk
Investment risk is the potential for an investor to experience losses (or potentially lower-than-expected returns) on their investments. All investments carry some degree of risk which can vary based on market conditions, the type of investment, and external influences such as economic changes or geopolitical events around the world. Usually, savvy investors will use strategies such as diversification or long-term investing to mitigate investment risk as much as possible.
Joint and Survivor Annuity
A joint and survivor annuity is a type of annuity contract that guarantees payments for the lifetimes of two people (usually a couple). This financial product ensures that if one person passes away, the surviving annuitant will continue to receive payments. The payment structure can vary, meaning that the survivor could receive a percentage of the original payment (often 50% or 75%). Married couples will often purchase joint and survivor annuities because they ensure that both partners will have a stable income throughout their lives.
Lifetime Income
A consistent stream of income that a person can expect to receive for the duration of their life. Lifetime income is often established through the purchase of annuities or other similar financial products and is particularly important for retirement planning because it ensures that you don't outlive your savings. It can also be generated through pensions, Social Security benefits, and annuities that specifically provide guaranteed payments. Payments can begin either immediately or at a set date in the future so that stable income is provided regardless of market fluctuations.
Loans from Retirement Accounts
The borrowing of funds from employer-sponsored retirement plans such as 401(k)s or 403(b)s. Taking a loan against your plan can offer you fast cash if you encounter financial difficulty, but there are rules to keep in mind—namely that you must repay the loan on time in order to avoid penalties and tax implications. You can often take out $50,000 or 50% of your vested account balance, whichever is less.
Long-Term Care Insurance
A specialized insurance product designed to cover the costs associated with long-term care services that are not typically covered by health insurance, Medicare, or Medicaid. Long-term care insurance provides financial assistance for those who need assistance with everyday activities due to chronic illness, disability, or cognitive impairment. Policies can cover various services including nursing care, personal care assistance, respite care, and more, and services can be provided either at home or in nursing homes or assisted living facilities.
Lump-Sum Distribution
A one-time payment made from a retirement or pension plan where the full balance is paid out in a single transaction instead of through recurring payments. Lump sum distributions usually occur when someone retires, stops working, or dies. If the amount isn't rolled into an IRA then taxes would be owed in the year it was received, so while it provides immediate access to funds, it's important to consider the tax and other long-term implications.
Medicare
A United States federal health insurance program designed primarily for those aged 65 or older. Part A covers hospital services such as stays, nursing care, hospice care, and some home health services. Part B covers outpatient care such as visits to the doctor, preventative services, and ambulance services. Part C refers to Medicare Advantage, which combines Part A and Part B coverage into private insurance plans that may include other benefits such as vision or dental. Part D covers self-administered prescription drugs.
Net Unrealized Appreciation (NUA)
The increase in value of employer stock held within an employer-sponsored retirement plan such as a 401(k) from the time it was purchased to the time it's distributed. NUA is calculated by subtracting the stock's cost basis from its market value at distribution. When a participant takes a lump-sum distribution of company stock they can defer taxes on the NUA until the stock is sold, meaning they can benefit from lower long-term capital gains tax on the appreciation. For those who have highly appreciated company stock, this strategy can provide significant tax savings compared to the ordinary income tax rates on regular distributions.
Non-Qualified Annuity
A financial product purchased with after-tax dollars, meaning the contributions made to the annuity are not tax-deductible. Unlike qualified annuities which are funded with pre-tax dollars from retirement accounts, non-qualified annuities allow for tax-deferred growth until withdrawal. When funds are withdrawn, the principal amount is returned tax-free and any investment gains are taxed as ordinary income. This type of annuity provides flexibility in terms of contributions as there are no annual limits, and there are no minimum distributions during the owner's lifetime, either.
Participant
A participant is an individual person who is enrolled in a retirement plan such as a 401(k) or pension plan and is eligible to contribute to or receive benefits from that plan. They can be employees of a company, members of a union, or people involved in other qualifying organizations, but all have rights and responsibilities with regard to their contributions, investment choices, and how their retirement accounts are managed.
Plan Document
A formal and comprehensive document outlining the rules, regulations, and provisions that govern a retirement plan or employee benefit plan. Plan documents provide details regarding eligibility criteria, contribution limits, benefits provided, distribution rules, and the various responsibilities of both plan sponsors and administrators. They're also required under the Employee Retirement Income Security Act (ERISA) as the legal foundation for the plan and ensure compliance with applicable laws in order to protect participants and sponsors from any potential legal issues that may arise.
Plan Sponsor
An employer or organization that establishes and maintains a retirement or benefit plan for its employees. The plan sponsor is responsible for designing the plan, determining eligibility and benefits, and making sure that applicable laws and regulations are followed and respected. They may also oversee the contributions to the plan and delegate certain administrative tasks to third-party service providers while retaining the fiduciary responsibility to act in the best interest of the plan's participants.
Qualified Domestic Relations Order (QDRO)
A legal document issued by a court that defines how retirement plan assets will be divided between spouses in the case of divorce. The QDRO must comply with all federal regulations under ERISA and outline details including the amount to be paid and the different plans involved. QDROs allow for tax-deferred funds transfers to another retirement account so that immediate taxation on the distributed amount can be avoided.
Rate of Return (RoR)
A financial metric that measures the gain or loss of an investment over a specific period of time. The rate of return is expressed as a percentage of the initial investment cost and calculated by subtracting the initial value from the current value, dividing the result by the initial value, and then multiplying it by 100. Naturally, a positive RoR indicates a profit, while a negative RoR means there has been a loss. This metric can be applied to various assets including stocks, bonds, real estate, and more, and is critical for evaluating investment performance.
Required Minimum Distributions (RMDs)
The minimum amount that must be withdrawn annually from certain retirement accounts—such as 401(k)s and traditional IRAs—starting at the age of 73. The first RMD must be taken by April 1 of the year following the individual's 73rd birthday, and the amount is calculated by dividing the account balance at the end of the previous year by a life expectancy factor published by the IRS. Failure to withdraw the required amount on time can result in significant tax penalties.
Retirement Benefits
Financial perks designed to ensure financial security in retirement that are provided to individuals when they end their active employment and leave the workforce. Retirement benefits usually include pensions, annuities, and contributions made to retirement accounts such as 401(k)s or IRAs. They can also include health or life insurance products to help retirees maintain a steady income and manage increasing healthcare costs once they stop working.
Rollover
A rollover is the process of transferring funds from one retirement account to another without incurring any tax penalties. This can happen when a person changes jobs and moves their 401(k) to a new employer's plan or when they rollover their old 401(k)s into a PensionBee IRA. Rollovers can be either direct, where funds are transferred directly between accounts, or indirect, where the person receives the funds and then has 60 days to deposit them in order to avoid taxes.
Roth IRA
A type of individual retirement account that allows individuals to contribute after-tax dollars, meaning that contributions are made with income that has already been taxed. The main advantage of Roth IRAs is that the contributions and earnings grow tax-free, and qualified withdrawals are also tax-free—provided the individual is at least 59½ years old and the account has been open for at least five years. Roth IRAs also don't require minimum distributions during the account holder's lifetime which provides more flexibility in retirement planning.
Simplified Employee Pension IRA (SEP-IRA)
A retirement savings plan designed for small business owners and those who are self-employed, allowing them to make tax-deductible contributions to their own and their employees' retirement accounts. Contributions to SEP-IRAs are made solely by the employer and have to be equal for all eligible employees who themselves have to meet specific criteria such as age and years of service.
Savings Incentive Match Plan for Employees IRA (SIMPLE IRA)
A retirement savings plan designed for small businesses with 100 or fewer employees that allows both employers and employees to contribute tax-deferred funds for retirement. Employers can choose to match employee contributions up to 3% of their compensation or make a non-elective contribution of 2% for all eligible employees regardless of whether they contribute. Employees can then defer a portion of their salary into the plan with contribution limits set at $16,000 for 2024 (plus an additional catch-up contribution for those aged 50 or over).
Social Security
A United States federal program that provides retirement benefits, disability income, and survivor benefits to eligible people and their families. Social Security is managed by the Social Security Administration (SSA) and is funded via payroll taxes collected from both employees and employers. Individuals must be 62 years old to qualify for Social Security benefits and have contributed to the system for a minimum of 10 years.
Solo 401(k) Plan
A Solo 401(k) or one-participant 401(k) plan is a retirement savings option for small business owners and self-employed individuals who have no employees (other than their spouse). This plan type allows participants to make contributions as both an employee and employer with higher contribution limits compared to other retirement plans. In 2024, the contribution limit for a Solo 401(k) plan is $23,000 (or 100% of compensation, whichever is less) with an additional catch-up contribution of $7,500 for those aged 50 and over.
Spousal IRA
A type of individual retirement account that allows a working spouse to contribute to a non-working spouse's retirement savings. The couple has to file a joint tax return to qualify, and contributions can be made to either a traditional or Roth IRA with the same contribution limits as regular IRAs. Spousal IRAs enable couples to effectively double their retirement savings while making sure that the non-working spouse has assets listed in their own name. This is a particularly beneficial account for those who have left the workforce to raise a family.
Target Date Fund (TDF)
A type of mutual fund designed to automatically adjust its asset allocation over time based on a specific retirement date or investment goal. Target date funds usually start with a higher proportion of equities and then shift toward more conservative investments as the target date gets closer. This gradual transition is called the "glide path" and it helps to reduce risk as investors approach retirement.
Tax Bracket
The range of income that is taxed at a specific rate within a progressive tax system where the tax rates increase with income. In the United States, the federal income tax system contains seven tax brackets for individuals ranging from 10% to 37%. Only the income within each range is taxed at the corresponding rate, meaning that a person filing alone would pay 10% tax on their income up to $11,600, and then progressively higher rates on the remaining income above the initial bracket.
Taxable Income
The portion of an individual's (or entity's) gross income that is subject to taxation after accounting for deductions and tax exemptions. Taxable income is calculated by taking the total income earned (including wages, salaries, bonuses, investment income, etc.) and subtracting deductions such as retirement contributions or student loan interest. The result represents the amount that will be taxed at the rate attributed to the tax bracket that the individual's income falls under.
Tax-Deferred Growth
The accumulation of investment earnings (interest, dividends, and capital gains) that are not subject to immediate tax liability until funds are withdrawn. 401(k)s and traditional IRAs feature tax-deferred growth as they allow investments to compound over time without the requirement of annual taxes that would otherwise significantly reduce overall returns. Contributions are often made with pre-tax dollars (which reduces the amount of taxable income for the year) and taxes are only paid upon withdrawal during retirement when the retiree is likely to fall under a lower tax bracket.
Traditional IRA
The most common type of individual retirement account (IRA) that allows individuals to contribute pre-tax income so their investments can grow tax-deferred until withdrawal. In 2024, contribution limits are set at $7,000 and must be made from earned income. Contributions may be tax-deductible depending on the individual's income level and whether or not their spouse is covered by an employer-sponsored retirement plan.
Vesting Period
The short-term timeframe that an employee has to work for a company before they can earn full ownership of certain benefits, such as employer contributions to a retirement plan. During the vesting period, employees might not have access to all benefits, though once the vesting period is complete, they would have the right to those benefits even if they leave the company.
Vesting Schedule
A timeline that outlines when an employee earns full ownership of benefits—such as retirement contributions—over a specified period. The vesting schedule usually includes specific intervals at which portions of the benefits become vested. An example might be 25% vesting after one year of service with the remaining benefits vesting monthly or quarterly after that, with the goal of incentivizing employees to stay with the company long enough to fully benefit.
Withdrawal Rate
Known as drawdown percentage outside of the United States (such as in the United Kingdom), withdrawal rate is the percentage of an individual's retirement savings that can be withdrawn annually to cover expenses without depleting the account prematurely. A widely referenced guideline is the 4% rule, which suggests that retirees can withdraw 4% of their initial balance each year (adjusted for inflation) to ensure that their savings last for 25 years. Withdrawal rates can vary based on investment performance, inflation, and the spending needs of the specific individual.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.
