A 403(b) plan, sometimes known as a tax-sheltered annuity (TSA) or a tax-deferred annuity (TDA), is an employer sponsored, tax-deferred retirement savings plan for employees of not-for-profit organizations, such as colleges, hospitals, foundations, and cultural institutions. Some employers offer 403(b) plans as a supplement to — rather than a replacement for — defined benefit pensions.
These tax-deferred retirement savings plans are available to state and municipal employees. Like 401(k) and 403(b) plans, the money you contribute and any earnings that accumulate in your name are not taxed until you withdraw.
Asset allocation is a strategy for maximizing gains while minimizing risks in your investment portfolio. Specifically, asset allocation means dividing your assets on a percentage basis among different broad categories of investments, including stocks, bonds, and cash.
Different categories of investments that provide returns in different ways are sometimes described as asset classes. Stocks, bonds, cash and cash equivalents, real estate, collectibles, and precious metals are among the primary asset classes.
Balanced funds are mutual funds that invest in a combination of common stock, preferred stock, and bonds to meet their dual investment goal of seeking a strong return while minimizing risk.
A stock market benchmark is an index or average whose movement is considered a general indicator of the direction of the overall market and against which investors and financial professionals may measure the performance of individual stocks or market sectors. There are also benchmarks for other types of investments, such as bonds, mutual funds, and commodities.
Capital gains tax (CGT)
A capital gains tax is due on profits you realize on the sale of a capital asset, such as stock, bonds, or real estate. Long-term gains, on assets you own more than a year, are taxed at a lower rate than ordinary income while short-term gains are taxed at your regular rate.
Cash balance plan
A cash balance retirement plan is a defined benefit plan that has some characteristics of a defined contribution plan, such as portability. The pension benefit accrues over time from contributions, based on a percentage of your current pay, which are credited to a hypothetical account in your name.
A contrarian is an investor who buys things other investors are shunning. If most investors are buying stocks, a contrarian is concentrating on building a bond portfolio or putting more money into cash investments. Contrarian mutual funds use this approach as their investment strategy, concentrating on building a portfolio of out-of-favor (and therefore often undervalued) investments.
A person or company who provides credit to another person or company functions as a creditor. For example, if you take out a mortgage or car loan at your bank, then the bank is your creditor. But if you buy a bond issued by a corporation or other institution, you are the creditor because the money you pay to buy the bond is actually a loan to the issuer.
A deferred annuity contract allows you to accumulate tax-deferred earnings during the term of the contract and sometimes add assets to your contract over time. Your deferred annuity earnings may be either fixed or variable, depending on the way your money is invested. Deferred annuities are designed primarily as retirement savings accounts, so you may owe a penalty if you withdraw earnings before you reach age 59 1/2.
Defined benefit plan
A defined benefit plan provides a specific income for retired employees, either as a lump sum or as a pension, or lifetime annuity. The pension amount usually depends on the employee's age at retirement, final salary, and the number of years on the job.
Defined contribution plan
A defined contribution plan is an employer sponsored retirement plan. The income the plan provides is not predetermined or guaranteed, as it is with a defined benefit pension. Rather, it varies according to how much is contributed to the plan, how the contributions are invested, and what the return on that investment is. 401(k), 403(b), 457, and profit-sharing plans are examples of defined contribution plans.
Diversification is an investment strategy for spreading your principal among different markets, sectors, industries, and securities. The goal is to protect the value of your overall portfolio in case a single security or market sector takes a serious downturn and drops in price.
Employer sponsored retirement plan
Employers may offer their employees either defined benefit or defined contribution retirement plans, or they may make both types of plans available. Any employer may offer a defined benefit plan, but certain types of defined contribution plans are available only through specific categories of employers. However, employers are not required to offer plans.
Equity mutual funds invest primarily in stocks. The particular stocks a fund buys depends on the fund's investment objectives and management style.
Growth and income fund
These mutual funds invest in securities that provide a combination of growth and income. They generally funnel most of their assets into common stocks of well-established companies that pay regular dividends. They may also invest in high-rated bonds.
Guaranteed investment contract (GIC)
A GIC (pronounced gick) is an insurance company product designed to preserve your principal and to provide a fixed rate of return. You may invest in a GIC through an employer sponsored salary reduction plan, such as a 401(k) or 403(b), if it is one of the investment options offered.
A hardship withdrawal occurs when you take money out of your 401(k) or other qualified retirement savings plan to cover a pressing financial need. You must qualify to withdraw by meeting the conditions your plan imposes in keeping with Internal Revenue Service (IRS) guidelines. If you're younger than 59 1/2, you may have to pay a 10% penalty, plus income tax, on the amount you withdraw, and you may not be permitted to contribute to the plan again for a period of time.
Highly compensated employees
Highly compensated employees are people who earned more from their employer than the floor the government has established for this category of worker. In 2003, that amount is $90,000. The drawback of being highly compensated is that what you can contribute to a 401(k) may be restricted
An index mutual fund is designed to mirror the performance of a stock or bond index, such as Standard & Poor's 500-stock Index (S&P 500) or the Russell 2000 Index. To do that, the fund purchases all of the securities included in the index, or a representative sample of them, and adds or sells investments only when the securities in the index are changed.
Individual retirement account (IRA)
Individual retirement accounts (IRAs) are self-directed investment accounts that provide the incentive of tax-deferred (in the case of traditional IRAs) or tax-free (in the case of Roth IRAs) earnings on assets in the account. If you earn income, or are married to someone who does, you can put up to $3,000 per year in an IRA in 2003. If you're 50 or over, you can invest an additional $500 each year.
You must be at least 59 1/2, or qualify for an exception, to withdraw from your IRA without owing a 10% penalty. You must begin required withdrawals from traditional IRAs when you turn 70 1/2, and all earnings (plus any deductible contributions) are taxed at your current tax rate as they are withdrawn. Roth IRAs have no required withdrawals and any money you do take out is tax free if you are 59 1/2 or older, provided your account has been open at least five years.
A lifecycle fund, sometimes called a fund of funds, is a package of individual mutual funds that a fund company puts together to help investors meet their investment objectives without having to select portfolios of funds on their own
A liquid investment is one that can be bought or sold quickly in large volume without affecting its market price. However, the term is sometimes used more generally to describe investments you can buy or sell easily, including mutual funds and most publicly traded stocks and bonds. It may also be used to describe those investments you can sell or cash in easily without loss of principal, such as a money market fund or a certificate of deposit (CD).
A lump-sum distribution is a one-time payout of assets in an account, typically a retirement savings account. When you retire or change jobs, you can take a lump-sum distribution as cash, or you can roll over the distribution into an individual retirement account (IRA). If you take the cash, you owe income tax on the full amount of the distribution, and you may owe an additional 10% penalty if you're younger than 59 1/2. If you roll over the lump sum into an IRA, the full amount continues to be tax deferred, and you can postpone paying income tax until you withdraw from the account.
A managed account is a portfolio of stocks or bonds owned by an individual investor. The account has a professional investment manager who makes buy and sell decisions, sometimes in response to the account owner’s instructions. Each managed account has an investment objective, and each manager oversees multiple individual accounts invested to meet the same objective.
Market capitalization is a measure of the value of a company, calculated by multiplying the number of existing shares, or shares the company has issued, by the current price per share. For example, a company with 100 million shares of stock with a current market value of $25 a share would have a market capitalization of $2.5 billion. Market capitalization is sometimes used interchangeably with market value.
A market index measures changes in the value of a specific group of stocks, bonds, or other investments that it tracks from a specific starting point, which may be as recent as the previous day or some date in the past. An index may be broad, encompassing a large number of stocks or bonds, or quite narrow, including only a limited number.
Minimum required distribution (MRD)
A minimum required distribution is the smallest amount you can take each year from your 401(k), 403(b), traditional IRA, or other retirement savings plan once you've reached the mandatory age for making withdrawals, usually 70 1/2. If you take less than the required minimum, you owe a 50% penalty on the amount you should have taken. You calculate your MRD by dividing your account balance at the end of your plan's fiscal year — usually but not always December 31 — using a divisor determined by your age.
Monte Carlo simulation
A Monte Carlo simulation generates thousands of probable performance outcomes, called scenarios, which might occur in the future. An investment simulation incorporates economic data such as a range of potential interest rates, inflation rates, tax rates, and so on, combined in random order. As a result, it's designed to account for the uncertainty and performance variation that's always present in financial markets.
Net asset value (NAV)
The NAV is the dollar value of one share of a mutual fund. It is calculated by totaling the value of all the fund's holdings and dividing by the number of outstanding shares. That means the NAV changes regularly, though day-to-day changes are usually small.
Your 401(k) plan administrator is the person or more typically the company your employer chooses to manage the organization's retirement savings plan. The administrator works with the plan provider to ensure that the plan meets government regulations and that you and other employees have the information you need to enroll, select, and change investments in the plan, apply for a loan if the plan allows loans, and request distributions.
A 401(k) plan provider is the mutual fund company, insurance company, brokerage firm, or other financial services company that creates and sells the plan your employer selects.
A 401(k) plan sponsor is an employer who offers the plan to employees. The sponsor is responsible for choosing the plan, the plan provider, and the plan administrator, and for deciding which investments will be offered through the plan.
Principal can refer to an amount of money you invest, the face amount of a bond, or the balance you owe on a debt, aside from the interest. The principal is also a person for whom a broker carries out a trade, or a person who executes a trade on his or her own behalf.
A profit-sharing plan is a type of defined contribution retirement plan that employers may establish for their workers. The employer may add up to the annual limit set by Congress to each employee's profit-sharing account in any year the company has a profit to share, though there is no obligation to make a contribution in any year.
Real rate of return
The real rate of return on an investment is the rate of return minus the rate of inflation. For example, if you are earning 6% interest on a bond in a period when inflation is running at 2%, your real rate of return is 4%. But if inflation were at 4%, your real rate of return would be only 2%.
If you move your assets from one tax-deferred or tax-free investment to another, it's called a rollover. For example, if you move money from one individual retirement account (IRA) to another IRA, or from a qualified retirement plan into an IRA, the transaction is a rollover.
A Roth IRA is an individual retirement account from which you can withdraw your earnings completely tax free any time after you reach age 59 1/2, provided your account has been open at least five years. However, to qualify to contribute to a Roth IRA, your income must be less than the level set by Congress. You may also qualify to convert a traditional IRA to a Roth IRA if your modified adjusted gross income (MAGI) in the year you convert is less than $100,000, whether you are single or married.
Salary reduction plan
A salary reduction plan is a type of employer sponsored retirement savings plan, which allows you to contribute pretax income to a retirement account in your name and to accumulate tax-deductible earnings. All salary reduction plans have an annual contribution cap that's set by Congress, and may allow annual catch-up contributions for participants 50 and older.
Sector mutual funds, also called specialty or specialized funds, concentrate their investments in a single segment of an industry, such as biotechnology, natural resources, utilities, or regional banks, for example. Sector funds tend to be more volatile than more broadly diversified funds, and often dominate both the top and bottom of annual mutual fund performance charts.
Self-directed retirement plan
A self-directed retirement plan is one in which you select the investments. When the plan is employer sponsored, you usually select from a menu of choices your plan offers. When it’s an individual retirement account (IRA), you typically may choose from the full range of investments other than collectibles and non-US coins. In contrast, if you’re part of a defined benefit pension plan, your employer is responsible for making the investment decisions.
Tax deferral means that income taxes that would otherwise be due on employment or investment earnings are postponed until some point the future, often when you retire. Then tax is due on the amounts you withdraw, at the same rate you pay on your regular income. For example, if you contribute pretax income to a retirement savings plan, such as a 401(k) or 403(b), you owe no tax on the contributions or any earnings in the plan until you withdraw. In other plans, such as individual retirement accounts (IRA), the contribution may be taxable but the earnings are tax deferred.
Total return is your annual gain or loss on an equity or debt investment. It includes reinvested dividends or interest, plus any change in the market value of the investment. When total return is expressed as a percentage, it's figured by dividing the increase in value, plus dividends or interest, by the original purchase price. On bonds you hold to maturity, however, your total return is the same as your yield to maturity (YTM).
When a mutual fund manager buys primarily undervalued stocks for the fund's portfolio with the expectation that these stocks will increase in value, that fund is described as a value fund. A value fund may be limited to stocks of a certain size, such as those included in a small-cap value fund, or it may include undervalued stocks with different levels of capitalization.
A variable annuity is a contract offered by an insurance company that can be used to accumulate tax-deferred retirement savings. You allocate your premium among a number of funds — also called subaccounts or investment portfolios — offered through the contract. Your contract value, which fluctuates over time, reflects the performance of the underlying investments held by the funds you have selected, minus the contract expenses. Withdrawals are taxed at your regular rate, but if they’re made before you reach age 59 1/2, you may also be subject to a 10% early withdrawal penalty.
If you are part of an employer pension plan or participate in an employer sponsored retirement plan, such as a 401(k), you become fully vested — or entitled to the contributions your employer has made to the plan, including matching and discretionary contributions — after a certain period of service with the employer. Qualified plans must determine the period using standards set by the federal government. If you leave your job before becoming fully vested, you forfeit all or part of those benefits.
Weighted stock index
In a weighted index, price changes in some stocks have a much greater impact than price changes in others in computing the direction of the overall index. By contrast, in an unweighted index, prices changes in all the stocks have an equal impact.
A price weighted index, such as the Dow Jones Industrial Average (DJIA), counts changes in the prices of its higher-priced securities more than changes in the prices of lower-priced securities. Similarly, a market capitalization weighted index, such as the Nasdaq Composite Index, emphasizes price changes in its securities with the highest market values, calculated by multiplying the current price per share by the number of existing shares.