12 Financial Terms Every Retirement Saver Should Know

Saving strategies

Every worker needs to make challenging decisions about how much to save and where to invest for retirement. While tax breaks and employer contributions can help you build a nest egg, investment options can be complicated, and it's difficult to know who to trust for financial advice. Here are some basic retirement investment terms every saver should be familiar with.

Fiduciary

A fiduciary is a financial professional who is legally required to recommend investments that are in the client's best interest, not the funds that make the biggest profit for the advisor. Beginning in April 2017, any advisor who makes investment recommendations to 401(k) or IRA participants will be considered a fiduciary. However, the new fiduciary standard applies only to tax-advantaged retirement accounts, so you will need to ask potential investment advisors if they are willing to act as a fiduciary for investments outside your retirement accounts.

401(k) plan

A 401(k) plan is an employer-sponsored retirement savings account that allows workers to defer paying income tax on their savings. Sometimes the employer will also make contributions to the account on behalf of workers or match employee deposits. There's typically a 10 percent penalty on withdrawals from the account before age 55, and distributions are generally required after age 70 1/2. Income tax is due on each withdrawal from the account.

401(k) fee disclosure statement

Every year 401(k) plan sponsors are required to send participants a 401(k) fee disclosure statement that explains the costs of each investment option. This document will list the annual gross expense ratio of each fund and the dollar amount you will be charged for every $1,000 you invest. You can also look up shareholder fees and specific actions that might trigger additional costs for each investment.

Vesting

While you always get to keep your own contributions to a 401(k) plan, you can't take your employer's deposits in the account with you if you leave the job before you are vested in the 401(k) plan. Some employers don't let you keep any of the 401(k) match until you stay with the company for several years, while others allow workers keep a percentage of the 401(k) match based on their years of service. You may not get to keep all of the 401(k) match until you stay with a company for five or six years. Pay close attention to the vesting schedule when making career decisions. While you may not want to pass up your dream job, in some cases sticking around for a few extra weeks or months could add thousands of dollars to your nest egg.

Automatic enrollment

Many 401(k) plans automatically enroll new and sometimes existing employees in the 401(k) plan. A portion of your paycheck is automatically withheld and deposited in a retirement account, even if you didn't initiate the transaction. The employer selects the savings rate and the default investment, which is most often a target-date fund. In some cases the contribution amount automatically escalates over time. Employees can generally opt out and stop contributions at any time.

Target-date fund

A target-date fund is a diversified investment that includes a mix of equities, bonds and cash. A fund manager gradually shifts the investment lineup to become more conservative over time. Target-date funds differ considerably in how conservatively they are invested when a worker turns 65, so it's worth double checking that the fund matches your risk tolerance. This is often the default investment for workers who are automatically enrolled in 401(k) plans.

Actively managed fund

Actively managed funds employ a professional fund manager to select which investments to buy and sell within the fund with the goal of superior investment performance. However, investment managers aren't always able to achieve returns that are significantly higher than a passive index fund that tracks the overall stock market. Actively managed funds frequently charge above-average fees in part to compensate the fund manager.

Index fund

An index fund is a collection of stocks or bonds designed to capture the returns of the entire stock or bond market or a specific sector of the market. Since there is no active management and little trading going on within the fund, investment costs and fees can be very low. An index fund is often a diversified investment and allows you to capture the gains of the stock or bond market.

Individual retirement account

An IRA allows workers to delay paying income tax on up to $5,500 that is deposited in the account. Workers age 50 and older can defer taxes on an additional $1,000. Withdrawals before age 59 1/2 typically trigger a 10 percent early withdrawal penalty, but there are exceptions if the money is withdrawn for specific purposes. Withdrawals are required after age 70 1/2, and income tax is due on each distribution unless is it transferred directly to a qualifying charity.

Roth IRA

Roth IRA contributions are made with after-tax dollars, but investment growth within the account is not taxed and withdrawals after age 59 1/2 from accounts at least five years old are tax-free. Roth accounts are often an especially good deal for young people and those currently in a low tax bracket. Roth IRAs don't have a withdrawal requirement during the lifetime of the original account owner, so the money can grow tax-free for the rest of your life and be used to pass on tax-free funds to heirs. Some employers also offer a Roth 401(k) option, which has a higher contribution limit and a withdrawal requirement in retirement.

MyRA

The money you invest in a myRA is guaranteed by the government never to decline in value, so there's no risk of losing money. The only investment option is a U.S. Treasury retirement savings bond that produces a variable and typically modest return. You won't have to pay tax on the investment gains while the money is in the account or on withdrawals you take after age 59 1/2. However, once you accumulate $15,000 or hold the account for 30 years, you will be required to transfer your balance to a private sector Roth IRA.

Saver's credit

Individuals who save in a retirement account while earning less than $30,750 for individuals and $61,500 for couples in 2016 might qualify for the saver's credit. This tax credit is worth between 10 percent to 50 percent of the amount you deposit in a 401(k) or IRA up to $2,000 for individuals and $4,000 for couples. The saver's credit can be claimed in addition to the tax deduction for saving in a traditional 401(k) or IRA.