In the modern economy, the responsibility for retirement largely falls to the individual. Being educated about this process can mean the difference between spending your retirement in vacation mode and working an additional decade. To secure the future you want, it’s important to plan. The earlier you start figuring it out (and saving!), the better. Here is a glossary of essential terms to know.
This term gets thrown around a lot, and sometimes it’s used interchangeably with retirement savings. But a 401(k) is a specific kind of retirement plan. It is a tax-deferred savings and investment plan established by employers. A 401(k) allows employees to control how salary and assets are allocated among different types of investments.
An IRA is another kind of retirement plan. It does not require an employer to set it up for you. An IRA is a personal, tax-sheltered retirement account available to employed wage earners not covered by a company retirement plan or under certain income limitations. Any contributions to an IRA may be tax-deductible and earnings are not taxed until the funds are withdrawn after you reach age 59.
3. Roth IRA
This is yet another type of retirement plan. A Roth IRA is an “after-tax” retirement account funded with nondeductible contributions that are not taxed upon withdrawal. There are income limitations for both full and partial contributions.
This is a retirement account, like the 401(k), that is set up by the employer (or union). However, the difference is that a pension is also fully funded by the employer. It is a fund set up and invested by an employer or labor union to provide retirement income. These funds accumulate income and capital gains tax-free.
5. Social Security
Social Security is a federal program of social insurance that provides benefits to retired, unemployed or disabled people. It is funded by Social Security taxes that come out of your paycheck while you are working. Based on the year you were born, retirement benefits from Social Security may begin as early as age 62. The amount you will receive in retirement is based on the average payments earned over your lifetime and may also extend to spouses.
6. Compounding Interest
Compounding interest is the interest calculated by the principal or original amount in a retirement account as well as by the accumulated interest of previous periods. It is the concept that the interest you earn today will earn interest tomorrow.
This is a term that refers to the types of investments where applicable income, capital gains or other taxes are paid at a future date instead of when the investments are made.
8. Early Withdrawal Penalty
The early withdrawal penalty is a tax paid on assets withdrawn from a qualified retirement plan prior to retirement age, death or disability. This is usually a 10 percent penalty and comes in addition to any regular federal and state income taxes.
9. Employer Match
This term is often thrown around in conjunction with a 401(k). An employer match is the amount that some employers choose to contribute to an employee’s 401(k). It is an optional system usually used to provide a set percentage of an employee’s contribution up to a fixed limit. If your employer offers a match, it’s a good idea to make sure you are contributing at least enough to get the match. Otherwise, you are missing out on ‘free’ money.
An annuity is a contract that guarantees fixed or variable payments over time. Some investors buy annuities to experience a steady source of income for the future.
Now that you know these 10 crucial retirement terms, it’s important to review your current finances and your retirement goals and make sure you have a plan that gets you where you hope to go. Managing your credit well is also a very important part of maintaining good financial health throughout your lifetime. That includes keeping your debts low and at a level you can manage, making your payments on time every month, checking your annual free credit reports and regularly monitoring your credit scores (which you can do for free through Credit.com). This way you can ensure you're on your way to a happy retirement, whatever that may look like for you.
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