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Financial terms you should know

When it comes to managing your money and creating a retirement income strategy, how much do you like to be involved? There's a wide spectrum — some like to know the ins and outs; others don't.

You may be financially savvy, but your spouse or adult children may need some 101. Or maybe it's the other way around — you've left your financial strategy to others to manage but could benefit from knowing the basics.

Regardless of where you fall on the spectrum, it's important to understand some key retirement planning terms.

  • Defined contribution plan – An employer-sponsored retirement savings plan, such as a 401(k) or 403(b) plan, to which the employee contributes.
  • Defined benefit plan – An employer-sponsored retirement savings plan, also known as a pension plan, to which the employer is responsible for making contributions.
  • Individual Retirement Account (IRA) – An account you establish outside of an employer-sponsored retirement plan. You may transfer assets from an existing tax-deferred retirement plan (an account with a former employer, for example) to a Rollover IRA. Depending on your income and access to a retirement plan at work, you may make tax-deductible contributions to a Traditional IRA. If eligible, you may make after-tax contributions to a Roth IRA.
  • Contribution – Money an employee or employer sets aside in a retirement savings plan. Pre-tax contributions lower your current tax bill. In 2012, individuals age 50 and older can contribute $22,500 to an employer-sponsored retirement plan, subject to plan limits, and $6,000 total to all IRAs.
  • Roth – If eligible (you earn less than $125,000 if single or $183,000 if married), you may make after-tax contributions to a Roth IRA. Qualified distributions (taken at least five years after the first contribution is made and after you reach age 59-1/2) are not taxable. Some employer-sponsored retirement plans allow Roth contributions that are not subject to the same income limits as a Roth IRA.
  • Rate of return – How much an investment earns, usually shown as a percent of the total amount invested; often expressed on an annual basis.
  • Replacement ratio – The percent of your working income that you need to bring in during retirement. Many experts recommend 85 percent[1], although you may need more or less to maintain your standard of living in retirement.
  • Inflation – The overall increase in the price of goods and services, usually as measured by the Consumer Price Index. Due to inflation, the value of a dollar falls over time. An average annual inflation rate is 2.5 percent.
  • Retirement income plan – A strategy for generating income from your retirement savings.
  • Income solutions – Financial products that can help you generate income from your retirement savings.
  • Income annuity – A financial product for which the investor gives an insurance company a lump sum of money; in return, the insurance company provides regular payments to the investor for life or a specified period of time.*
  • Withdrawal rate – The percent of your retirement savings you can withdraw each year from savings. Many financial professionals recommend a rate of no more than 4 to 5 percent each year adjusted over time for inflation.
  • Required minimum distributions (RMDs) – The minimum amount an individual must withdraw each year from a retirement account, generally starting at age 70-1/2.

Learn more.

Want to learn more about retirement planning?

Visit our Planning Center today.


Aon Consulting 2008 Replacement Ratio Study.

*All annuity gurantees are subject to the claims-paying ability of the issuing insurance company. Withdrawals from a tax-advantaged savings plan may be subject to IRS early-withdrawal penalties if taken before age 59-1/2.

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that none of the member companies of The Principal are rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services are provided by Principal Life Insurance Company. Securities are offered through Princor Financial Services Corporation, 1-800-547-7754, Member SIPC and/or independent broker dealers. Securities sold by a Princor® Registered Representative are offered through Princor. Princor and Principal Life are members of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.


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