Financial Terms Dictionary

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.

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.

Come back soon. We will be adding more financial terms to our dictionary for you!

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