Investment, Savings and Retirement Definitions You Need to Know

Most people know what a 401(k) is and that retirement planning is essential to a healthy financial future. When you start the retirement planning process, however, investment, savings and retirement terms can create more confusion than clarity.

It is extremely important that you understand the role of your retirement plan in your overall savings and financial situation. If words stump you, it is important to seek out their definitions. Otherwise, it is possible to make serious mistakes in investment and savings decisions.

Vesting

There are different graduated vesting schedules, according to the Department of Labor, depending on when you leave your job and the type of benefits package you are given. The term vesting simply refers to the age and years of service an employee must accrue in order to receive full access to retirement benefits.

Vesting takes place in stages, usually according to years of service performed by the employee. For example, you might be only 50 percent vested after three years of service, but 100 percent vested after five years. This is one of the reasons why stable employment is essential to a healthy retirement savings plan.

Tax Deferral

One of the cornerstones of a retirement plan is the tax-deferred nature of the money you put into the fund. Tax deferral is the practice of storing money in a savings or investment plan for which you will pay taxes at a later date. This happens with a pension, 401(k), Keogh plan and others.

This is significant because your retirement plan earns interest over the years during which you aren't using it. When you extract money from the plan in retirement, you'll have to pay taxes on that income, but you'll have earned money on it in the interim.

Annuity

Considered a relatively safe, low-risk investment, an annuity is a type of insurance plan that pays out to the beneficiary in fixed installments over a period of time. Like a retirement account, there are penalties for withdrawing early from an annuity, and there are many different types to consider.

Variable annuities are higher-risk investments than fixed annuities because the payout sizes are not guaranteed. However, if the annuity performs better than expected, the payout might be greater than it would have been with a fixed annuity.

Contribution

Any time money is added to a retirement plan, annuity, or other savings plan, this is considered a contribution. The amount of the contribution might be increased if your employer offers a matching funds program.

For example, you might decide to contribute seven percent of your salary to your retirement plan. This is a contribution. Your employer might offer matching funds contributions up to six percent. In some cases, fund matching might be limited by both size and percent.

Profit Sharing

Some employers offer profit sharing benefits to their employees, often in the way of stocks. Employees might earn stock options depending on their years of service, for example, and the benefits of profit sharing might be deferred until retirement is reached.

Profit sharing programs can also be offered in the form of immediate cash, in which case that money is taxed as income right away. It is important to consider the best way to take advantage of profit sharing benefits so your savings and retirement plans are secure.

Flexible Spending Account

Although not directly beneficial to retirement planning, a flexible spending account can save employees from raiding their retirement plans in times of emergency. A flex account provides an employee with a specific amount of money to put toward certain expenses (which are described in the agreement).

The money in a flex account might be put toward unforeseen medical expenses not covered by insurance, for example, or toward temporary child care. Whatever the case, it is much better for employees to use flex funds than to dip into their retirement savings in an emergency.

Risk Assessment

A risk assessment is an evaluation of an individual's risk tolerance for investments as well as an evaluation of the risk of a particular investment. Conservative investments are considered low-risk, while aggressive investments are considered high-risk.

According to Investopedia, low-risk investments include government bonds, CDs, and money market accounts. Real estate investments are slightly higher up in the risk matrix, while futures and collectibles are even higher.

Knowing these retirement, savings and investment terms will help you make sensible decisions about your financial future.