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| Credit Answers > Debt Resources > Debt Glossary |
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Activities of Daily Living (ADLs): Basic and essential activities of daily living that are generally reimbursable from long-term insurance. The six activity categories include bathing, eating, dressing, continence, toileting and transferring. Transferring is moving between two places, as simple as moving from a bed to a bathroom or kitchen.
Adjustable Rate Mortgage (ARM): Adjustable rate mortgages are called ARMs for short. The lender changes the interest rate periodically in accordance with the loan agreement. For example, the loan agreement may say that the rate on a 1-year ARM is reset every Sept. 1 after an initial period of three years. The interest rate is calculated by adding a margin to an index rate. If the margin is 3 percentage points and the yield on the 1-year bill (assumed to be the index rate) is 6%, the loan rate is reset to 9%. ARM loans usually have provisions that limit how much the loan rate can increase at one resetting and over the term of the loan.
Adjusted Gross Income (AGI): Adjusted gross income (AGI) is total income minus certain allowable deductions. These deductions include amounts for IRA contributions, qualified student-loan interest, some expenses if self-employed, alimony payments, and moving expenses. AGI is shown on line 37 of the 2007 IRS Form 1040.
Administrative Fees: Administrative fees are fees paid yearly to the life-insurance company that sold you an annuity contract. They are also called contract maintenance fees. Administrative fees pay the insurer for such costs as marketing and distribution. Administrative fees are generally in the range of $30 to $50 a year.
After Tax Interest Rate: After-tax interest rate is the effective interest rate you pay on a loan if you deduct interest expense. For example, if you have an 8% loan and are in the 25% tax bracket, the after-tax interest rate is 8% multiplied by (1 minus 0.25), or 6.00%.
After Tax Return: Your after-tax return is your investment rate of return net of taxes. Assume you are in the 25% income tax bracket and qualify for the 15% capital gains rate. If you sell 100 shares for $15 that you paid $10 for 366 days ago and which earned $100 in dividends, your after-tax return is based on paying 15% on the $500 in capital gains and 15% on the $100 in dividends. After taxes, this equals $510. Divided by your $1,000 investment, your after-tax return is 51.0%.
Aggressive Investor An aggressive investor is an investor who is willing to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns. A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return.
Annual Exclusion: The annual exclusion is another name for the gift-tax exemption, which is the amount that is exempt from gift taxes. The annual exclusion for 2008 is $12,000.
Annual Fee: A fee that you pay a lender or credit card company for the privilege of credit. Annual fees generally apply to forms of open-end credit such as credit cards or home equity lines of credit. Annual fees for credit cards generally range from $10 to $75. Rewards cards generally charge a higher fee. Fees for a line of credit are often charged in the form of points, with 1 point equal to 1% of the credit line. When calculating your effective interest rate, you should include annual fees.
Annual Percentage Rate (APR): The real cost that you pay to borrow, stated as a yearly percentage of the loan amount. This is sometimes called your effective borrowing cost. For auto and mortgage loans, closing costs and discount points are added to calculate APR. For example, if you pay $500 in closing costs to obtain a $10,000 loan, the APR will be higher than the interest rate since you are effectively borrowing $9,500 but will owe $10,000. The Truth-in-Lending Act requires the lender to disclose the APR to you. For credit cards, the annual fee is often not included in the APR calculation. As a result, an APR of a credit card is often its simple interest rate.
Annual Percentage Yield (APY): Annual percentage yield (APY) is the interest rate you earn on a certificate of deposit (CD) or other fixed-term deposit. The APY calculation assumes that you hold the investment until maturity. APY is greater than the stated rate on the deposit if interest is compounded. For example, a bank may be selling a one-year CD at a stated rate of 10%. If the CD compounds interest on a quarterly basis, the APY rises to 10.38%. If compounded daily, the APY rises to 10.52%.
Annuity: An annuity is a series of payments. For example, a monthly payment of $1,000 for the next 120 months is a 10-year monthly annuity. Annuities are frequently used in retirement planning because of tax advantages that they offer. Insurance companies sell annuities contracts. A fixed annuity pays a constant amount. A variable annuity pays a variable amount that fluctuates with the investment performance of the underlying investments. Those underlying investments are called subaccounts.
Applicable Exclusion Limit: The applicable exclusion limit is the dollar value of your estate that is exempt from estate taxes. For 2008, the applicable exclusion limit is $2 million. It increases to $3.5 million in 2009.
Appraisal: Appraisal is the process of estimating fair market value of an asset. Appraisals are routinely required for real estate transactions. An appraiser should be a certified professional. He or she should be an independent party to the transaction in order to avoid potential conflict of interest. Real estate appraisers use methods that are common in local practice. Comparable-sales method is widely used to appraise real estate.
Appreciation: Appreciation is the increase in the value of an asset, measured in dollars or as a percentage. For example, an investment that rises in price to $25 from $20 has appreciated 25 percent.
Asset Classes: The major asset classes used to make asset allocation decisions are stocks, bonds, and cash. Several investment categories exist within each of these major classes. Other major asset classes include real estate, derivatives, private equity, precious metals, and foreign currencies.
Average Daily Balance Method: A method widely used by banks to calculate the interest due on a credit card or other form of open-end credit, such as a home equity line. To calculate, add your daily balances for each day in a billing period, which is usually 30 days. Divide by the number of days in the billing period. The result is your average daily balance. The lender multiplies this by the periodic interest rate to calculate how much interest you owe for the month. For example, if your total of daily balances equals $30,000 for a 30-day period, your average daily balance is $1,000. If the periodic interest rate is 12% (1% monthly), your interest expense would be $10.
Average Monthly Balance: Average monthly balance can represent an asset or liability. For assets, it is the amount you have deposited, on average, during one month. The average monthly balance for a bank account, for example, is the sum of ending daily balances divided by the number of days. For liabilities, average monthly balance is the amount that you owe on a debt, on average, during one month. You can also calculate an average monthly balance for periods longer than one month. For example, if the average monthly balance for April, May and June is, respectively, $2,500, $5,000, and $7,500, average monthly balance for the period is $5,000. Calculating your average monthly balance on a debt helps you to estimate your average interest expense.
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Base Rate: The interest rate that is used as a benchmark to set the interest rate for borrowers. A base rate is sometimes called an index rate. For example, if you obtain a one-year adjustable-rate mortgage, your loan rate will be reset once a year to a rate that equals the loan rate plus a margin. Interest rates on credit cards are frequently tied to a change in the prime rate, another popular base rate used in consumer lending.
Beneficiary: A beneficiary is a person or entity that is named as the legal recipient of the proceeds from a retirement account, insurance policy, trust, will or other fiduciary arrangement.
Billing Period: The number of days that a lender uses to calculate the interest you owe on a loan or credit card. This is usually 30 days.
Blind Trust: A blind trust is a trust agreement that does not specify to either the grantor or beneficiary how the trust assets are being managed. Blind trusts are set up to avoid potential conflicts of interest.
Bonds: A bond is a financial asset that represents a claim on the assets of the company or other entity that issued the bond. A bond is a form of an IOU. A bond issuer sells bonds to investors who agree to lend to the issuer for a specific bond term and at an agreed-upon interest rate. When the term ends, the bonds mature and are bought back by the issuer. Investors are repaid and collect any accrued interest. If a bond issuer files for bankruptcy or defaults on its debt, bond investors are first in line to be repaid. (Shareholders are last.) Bonds are often called fixed-income securities because they usually pay interest at a fixed interest rate. This fixed interest rate makes bonds a predictable source of income for investors. Together with stocks and cash investments, bonds make up one of the three major asset classes.
Break Even Point: When you refinance a mortgage, the decision is profitable if you are able to pass the break-even point. At the break-even point, the savings you receive from refinancing equal the costs. A common break-even analysis is to calculate how long you must live in a home after you refinance in order to recover the closing costs you paid to refinance. For investing in stocks and mutual funds, break-even analysis is used to calculate the minimum sale price that allows the buyer to recover the transaction costs from buying the shares. For business operations, a business reaches its break-even point when it generates enough sales to pay for all its fixed costs. For each additional dollar of sales, variable costs should be less than a dollar. As a result, each dollar of sales past the break-even point generates some profit.
Budget Variances: Budget variances are the difference in actual and budgeted income and expenses. If your budgeted expenses exceed your actual expenses, you have a positive variance. If your actual expenses exceed your budgeted expenses, you have a negative variance. As long as you rack up positive variances, you are able to set aside an amount to save. This savings amount should be about equal to the amount of the variance. Identifying budget variances is an important step in effective personal budgeting.
Budgeting: Budgeting is a process that starts with creating a plant to record all cash inflows and outflows. The process continues by adhering to a budget. Adherence requires discipline to make sure your budgeted cash outflows equal your budgeted inflows. A final step of the budgeting process is review of recent performance. Personal budgeting is a similar process that you put in place to manage your personal finances.
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Capital Gains Tax: Capital gains taxes are those taxes that you owe on capital gains. The capital gains tax rate is lower than the tax rate on your ordinary income. To qualify for the capital gains tax rate, you need to hold a capital asset (such as an investment or home) for more than one year. That means 366 or more days. Gains on capital assets held for more than one year are called long-term capital gains. Gains on capital assets held for one year or less are called short-term capital gains. Short-term capital gains are taxed at the same rate as ordinary income. The long-term capital gains tax rate for most taxpayers is 15%. However, if you are in the 10% or 15% income tax bracket, the long-term rate is 0%.
Capital Preservation: Capital preservation is an investment goal that leads to an investing style of not losing money (investment capital). If capital preservation is a financial goal, the spectrum of investments will be limited to less risky securities. As a result of the risk-return trade-off, these investments will have lower investment returns. Investors approaching retirement slowly adopt a capital-preservation style since they have less time to recover from a poor year of returns.
Cash: Together with stocks and bonds, cash is an asset class. Asset classes define the universe of investments used in making asset allocation decisions. In addition to greenbacks, cash assets include saving and deposit accounts, money market accounts (MMAs), money market mutual funds, short-term certificates of deposit (CDs), and Treasury bills. Cash is the base currency used for buying and selling goods and services in an economy. As a result, it is the most liquid and least-risky form of currency. However, its low risk relative to that of other asset classes results in a lower rate of return.
Cash Advance Fee: A fee charged by a credit card company for the privilege of drawing cash from your borrowing limit. Unlike a regular charge, cash advances begin incurring interest from the day you take the advance. The interest rate is often the maximum allowable rate.
Cash Inflows: Cash inflows are dollars (or relevant currency) that you receive on an investment. Cash inflows are a payback, or source of cash, on an investment. Cash outflows, o the other hand, are dollars (or relevant currency) that you spend or invest in order to earn a rate of return. Cash outflows are uses of cash. The interest rate that equates the cash inflows and outflows for a project, even one extending many years, is called the internal rate of return.
Cash Outflows: Cash outflows are dollars (or relevant currency) that you spend or invest in order to earn a rate of return. Cash outflows are uses of cash. Cash inflows, on the other hand, are dollars (or relevant currency) that you receive on an investment. Cash inflows are a payback, or source of cash, on an investment. The interest rate that equates the cash outflows and inflows for a project, even one extending many years, is called the internal rate of return.
Cash Rebate Card: A rewards card that gives the cardholder a discount for each dollar in purchases. Sometimes, this is rewarded as a cash deposit at the end of the year. There is a yearly limit to the size of cash rebate that can be earned in a year.
Cash Value: Cash value is a dollar value that is returned to an insurance policyholder if the policy is canceled. Cash value is also called cash surrender value (CSV). Cash value is a feature of a permanent life insurance, including whole, variable, and universal life. Cash value fluctuates with the investment performance of a life insurance contract. In some cases, it may be guaranteed. Cash value may be used as a source of borrowing for the policyholder and is treated as a tax-deferred investment.
Catch Up Provision for Contributions to Retirement Plans: The Economic Growth and Tax Relief Reconciliation Act of 2001 authorized higher yearly contribution limits to IRAs, 401(k) plans and other defined-contribution retirement plans. A catch-up provision of the new law authorized even higher limits for workers who are age 50 or older. For 401(k)s, the yearly limit increases to $20,500 in 2008.
Ceiling Rate: The maximum interest rate that a lender can charge you. This rate is usually automatically imposed if you become delinquent in your payments.
Certificate of Deposit (CD): A certificate of deposit (CD) is a time deposit that you make at a bank. You can also buy a CD from a broker who is selling them for other deposit-taking institutions. Deposit periods of CDs are generally between three months and five years. Deposit amounts generally range from $500 to $100,000. Since the FDIC guarantees up to a limit of $100,000 per depositor per institution, you may wish to avoid investing in multiple CDs at one institution for amounts over $100,000 . After all, CDs pay a lower interest rate in exchange for deposit insurance. If you are going to risk some of your investment, you should be compensated with a potential higher rate of return that non-insured investments may offer.
Charitable Organization: A charitable organization, or charity, is a non-profit organization that is usually qualified under section 501(c)(3) of the federal tax code order to receive tax-exempt status. Charitable organizations such as churches do not have to register as 501(c)(3) corporations. Charitable organizations focus on providing social services that are often inadequately funded by government social-services programs. Contributions that you make to a charitable organization are tax-deductible. Generally, you can not deduct an amount greater than 30% or 50% of your adjusted gross income, depending on the type of contribution.
Cleanup Period: A personal or home-equity line of credit may specify a cleanup period in the borrowing agreement. A cleanup period requires the borrower to periodically pay down the credit line to zero in order to maintain the lending agreement.
Closed End Credit: Closed-end credit is loan or other form of credit that requires the borrower to repay the loan without the privilege of borrowing any repaid loan amounts. An amortizing loan is a common form of closed-end credit.
Closing Costs: Closing costs are the total expenses that the buyer pays at the time a real estate transaction is completed. This stage of the transaction is called "closing." Closing costs include application, underwriting and loan-origination fees; mortgage points; title search and insurance; fees for related legal services; and costs to fund an escrow account. For home mortgage loans, closing costs generally range between 3 and 6 percent of the home purchase price.
Collateral: Collateral is an asset that is used to secure the repayment of a loan. Also called security. For example, if a borrower defaults on an auto loan, the lender has the right to sell the collateral in order to collect on the loan. The same principle works on most mortgage loans, which are collateralized by the homes that the loans are used to buy.
Collection Agency: A lender or other creditor uses a collection agency to collect from you a debt that you may owe to the creditor. Creditors have limited resources to spend collecting bad debts. Collection agencies, on the other hand, specialize at this task.
Compounded Interest: Compounded interest is the interest that you earn on a deposit or investment that uses compounding. Banks and financial institutions routinely use compounding to pay you a higher interest rate. For example, a bank may be offering a CD that pays interest at 10%. If the bank does not compound interest, you will receive 10% of your investment as interest income at the end of a year. But if the bank compounds interest every three months, you will earn an interest rate of 10.38%. If the bank compounds interest monthly, you will earn 10.47%. And if it compounds daily, you will earn 10.52%. For a $10,000 deposit, this is an extra $52 in interest that you earn.
Compounding: Compounding adds the interest you earn on an investment and invests it, plus the original investment, for another period. The result is that you earn more interest and a higher rate of return. For example, if you invest $10,000 at 10% for one year with no compounding, you would receive $1,000 in interest at the end of the year. But if the bank compounded your interest every three months, you would earn $250 after the first three months, which is added to the original deposit of $10,000 and invested for another three months. After three more months, your $10,250 investment would earn $256.25 in interest. The process is repeated so that at the end of the year you earn $1,038 in interest. This is $38 more than if there were no compounding. Compounding is also determined by the frequency that you roll over the interest. For example, a bank may offer 10% on a one-year $10,000 CD. If there is no compounding, you will receive $1,000 in interest at the end of the term. If interest is compounded every three months, the rate is 10.38%. If compounded monthly, the rate is 10.47%. If compounded daily, the rate is 10.52%. For a $10,000 deposit, an extra 52 basis points in the interest rate is equal to an extra $52 in interest.
Compounding Frequency: The frequency that a bank compounds interest on your deposit. Banks and financial institutions routinely use compounding to pay you a higher interest rate. For example, a bank may be offering a CD that pays interest at 10%. If the bank does not compound interest, you will receive 10 percent of your investment as interest income at the end of a year. But if the bank compounds interest every three months (quarterly compounding), you will earn an interest rate of 10.38%. If the bank compounds interest monthly, you will earn 10.47%. And if it compounds daily, you will earn 10.52%. For a $10,000 deposit, this is an extra $52 in interest that you earn.
Conservative Investor: An investor who is unwilling to accept a higher degree of investment risk in exchange for a chance to earn a higher rate of return. Investment risk is the volatility of investment returns. A basic investing principle states that a higher degree of investment risk is required to earn a potential higher rate of return.
Consolidation: Loan consolidation combines multiple loans with higher interest rates or larger payments into a single loan with a lower interest rate or payments. Loan consolidation is similar to a refinancing but is usually done to reduce payments or the interest rate. Other reasons to consolidate include switching to a fixed-rate loan from a variable-rate loan or vice versa and changing the length of the loan term.
Cost Of Living Adjustment (COLA): The U.S. government pays a cost-of-living adjustment (COLA) to qualified federal employees and to all Social Security beneficiaries. COLAs are used to equalize cost-of-living differential and to protect against inflation. COLAs are based on the change in a widely used price index. For 2008, Social Security beneficiaries will receive a COLA of 2.3% for their benefits. This increase in benefits is based on the change in the consumer price index in the year ended in September 2007. Federal workers in Hawaii, Alaska, and the U.S. territory of Guam receive a salary COLA to compensate for the higher-than-average cost of living in those places.
Contract Value: The contract value of an annuity depends, in part, on whether it is a fixed or variable annuity. A fixed annuity's contract value is generally equal to the amount of purchase payments minus any withdrawals you make. A variable annuity's contract value is generally equal to the amount of purchase payments minus any withdrawals, then adjusted for the current value of subaccount investments.
Contribution: A contribution is the amount you invest in a taxable or tax-advantaged account. A lump-sum contribution is a single deposit. Periodic contributions are deposits you make on a regular basis. For 2008, you may contribute up to $5,000 to an IRA and $15,500 to a 401(k) or similar employer-sponsored retirement plan. A catch-up provision allows persons age 50 or older to contribute $6,000 and $20,500, respectively, to an IRA and 401(k) or similar employer-sponsored retirement plan.
Cost Benefit Analysis For autos: an analysis that compares the cheaper of a) borrowing money to buy a car and paying the interest, with b), paying cash for a car, and losing the opportunity to earn a rate of return on the savings applied to the purchase. For homes: an analysis that subtracts the benefits of homeownership from the costs of homeownership to obtain a net cost. Included in costs are mortgage interest, discount points, closing costs, property taxes and homeowner's insurance, home maintenance costs, and any private mortgage insurance (PMI). Included in benefits are the tax savings on deductions for mortgage interest (including points) and property taxes, and an increase in equity that you receive either from repayment of the loan principal or an appreciation in the value of your home.
Cost of Living Adjustment (COLA): The U.S. government pays a cost-of-living adjustment (COLA) to qualified federal employees and to all Social Security beneficiaries. COLAs are used to equalize cost-of-living differential and to protect against inflation. COLAs are based on the change in a widely used price index. For 2008, Social Security beneficiaries will receive a COLA of 2.3% for their benefits. This increase in benefits is based on the change in the consumer price index in the year ended in September 2007. Federal workers in Hawaii, Alaska, and the U.S. territory of Guam receive a salary COLA to compensate for the higher-than-average cost of living in those places.
Credit: Credit is the privilege of borrowing money. Before it makes a loan to you, a lender requires that you complete a credit application and meet its criteria of credit quality. A lender will review your ability to repay the loan based on income, personal net worth, credit history, and the value of collateral. Credit that is made with no collateral, such as a credit card or personal line of credit, is called unsecured credit.
Credit History: A credit report is a summary of an individual'credit history. It shows loan payment history, late payments, existence of liens or other encumbrances, debt forgiveness, bankruptcy filings, and number of inquiries by prospective lenders.
Credit Limit: Credit limit is the maximum amount a borrower is authorized to use. Credit limits are used for lines of credit and other forms of revolving credit such as a credit card.
Credit Rating: Credit rating agencies issue a letter-grade credit rating that reflects the financial health of the rated company. Credit rating agencies analyze financial statements and other data before assigning a credit rating. Agencies also rate individual bond issues based on how the issue will affect the financial health of the issuing company. Credit ratings are extremely important in determining borrowing costs. A credit rating of single-A or higher indicates the company has the financial resources to meet all claims by an adequate margin or to repay a bond issue. Investment-grade credit ratings include those that receive at least a triple-B rating.
Credit Report: A credit report is a summary of an individual's credit history. It shows loan payment history, late payments, existence of liens or other encumbrances, debt forgiveness, bankruptcy filings, and number of inquiries by prospective lenders.
Credit Risk: Often called default risk, this is the chance that the person or institution you are lending to is unable to repay your debt.
Credit Score: A credit bureau calculates your credit score and submits it to a lender to assist in making a credit decision. The credit bureau uses software from Fair, Isaac and Co. to calculate the score (as a result, a credit score is also called a FICO score). Your credit score is one determinant of a lender's credit decision. The lender also adheres to loan-approval guidelines that are set by the company itself. Credit scores do not have information on your age, gender, color, religion, marital status, and employment. Other factors, such as your employment history, are also excluded. According to Fair, Isaac and Co., about one-fifth of scores lay in each of the following ranges: below-620, 620-690, 690-745, 745-780, and 780-above.
Current Value: The current value is the value of your assets on a given date. Current value is also called market value. For example, the current value of your retirement account as of today may be $100,000. This is the total current value of the stocks, bonds, cash and mutual funds that are in the account. In the case of most securities, current values can be determined every day, even at a given point in time. For less-liquid assets, such as real estate or collectibles, current value may require a professional appraisal.
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Daily Balance: The amount you owe at the end of the day on a credit card or other form of open-end credit, such as a home equity line. The amount changes whenever you make a payment or use credit. Lenders calculate your interest based on an average of your daily balances over a billing period.
Death Benefit: A death benefit is an amount that is paid to the beneficiary of a life insurance policy upon the death of the policyholder. The amount may be a lump sum or annuity. The IRS generally considers a death benefit to be nontaxable income. For variable annuities, a death benefit is paid to the beneficiary if the contract owner dies before annuity payments begin.
Deduction: A deduction is an amount that you subtract from your taxable income. As a result, a deduction lowers your taxable income, which, in turn, lowers your tax liability.
Default: When you fail to repay a loan under the terms of the loan agreement, you trigger a loan default. This allows the lender to take extra steps to recover the loan. If it is a student loan that on which you are in default, you are generally ineligible to receive federal financial aid.
Defined Benefit Retirement Plan A pension plan where the employer funds employee retirement benefits by investing a fixed amount according to years of service and salary. Many defined benefit plans are guaranteed by the Pension Benefit Guaranty Corp.
Defined Contribution Retirement Plan An employer-sponsored plan in which contributions are made to individual participant accounts and the final benefit consists solely of assets (including investment returns) that have accumulated in these individual accounts. Depending on the type of defined contribution plan, contributions may be made either by the company, the participant, or both. (Source: Profit Sharing 401k Council of America)
Delinquent: A status that suggests to a lender that you are late in paying your debts. Being delinquent on your debts often means being more than 30 days late twice or 60 days late once. Being delinquent often means your account is handed over to a collection agency for collecting payment. This step not only results in you being called at home for payment, but also undermines your credit history.
Discount Rate: The discount rate is the interest rate the Federal Reserve, the U.S. central bank, charges banks on loans the Fed makes at its discount window. Banks seldom borrow at the discount window, since the Fed is considered a lender of last resort. The discount rate is important, however, in that it is routinely used as an index rate by the lenders to set interest rates on a range of consumer loans. This includes auto, credit card, and home equity loans. As a general rule, the Fed lowers the discount rate when it changes its target for the fed funds rate.
Distribution: Distributions are the amount that you take out from a retirement or other tax-advantaged account, such as a college savings plan, on a periodic basis. For regular IRAs and company-sponsored retirement plans, you are required to take minimum yearly distributions that are based on your life expectancy. These are called required minimum distributions (RMDs). Roth IRAs and variable annuities do not have required minimum distributions. Amounts for required minimum distributions are based on your age, IRA account balance and life expectancy. To calculate your RMD, divide your year-end IRA account balance (adjusted for certain contributions and distributions) by the applicable divisor in Table III: Distribution Period Table, found in Appendix C of IRS Pub. 590.
Dollar Cost Averaging: An investing technique that requires you to set aside a fixed amount at regular intervals to buy shares of an investment. It does not matter what the current price is. Since share prices normally rise and fall, your cost to acquire the investment over time is, on average, cheaper than attempting to time your purchases. Market and investment experts recommend the use of dollar-cost averaging.
Drawdowns: Draws, or drawdowns, are other names for withdrawals that you make on a line of credit. With a credit line, you only pay interest on the amount of your withdrawals, and only for the period that you have borrowed the money.
Due Diligence: Due diligence is the act of ensuring that the financial-services company you are buying a financial product from is properly licensed and has the financial resources to protect your assets.
Dying Intestate: Dying without leaving a will or trust to specify transfer of title of your assets to your beneficiaries after you die. As a result, the court appointed by the state of your residence will determine how your assets are distributed.
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Early Redemption Fee: Mutual funds: A fee that may be charged if fund shares are redeemed in a very short period, often 90 or 180 days. CDs or other time deposits: A fee that is charged if you redeem the deposit before its contracted maturity date.
Early Withdrawal Penalty: A penalty on the amount of any unauthorized withdrawal from a tax-advantaged account. In the case of 401(k) plans and IRAs, the IRS levies a 10 percent penalty on the amount that you withdraw. This is in addition to what you owe in income taxes.
Effective Interest Rate: The effective interest rate is your true interest-rate cost of borrowing stated as an annual rate. It may be shown on an after-tax basis, adjusting for a mortgage interest deduction. The effective rate on a mortgage or consumer loan includes fees, points and other charges that you pay when you close the loan. The effective rate also includes compounded interest. Higher closing costs or more frequent compounding result in a higher effective interest rate.
Elective Contributions: An employer that contributes to a SIMPLE plan for its employees may choose to make elective or non-elective contributions. Elective contributions are for 3% of the compensation of the employee, up to $6,900 for 2008. Elective contributions are matching contributions, which means that they are made if the employee makes salary-reduction contributions. Non-elective contributions are for 2% of the compensation of the employee, up to $4,600 for 2008. Non-elective contributions are made whether or not the employee makes salary-reduction contributions.
Elective Deferrals: Elective deferrals are the dollar or percentage amount that you have your employer deduct from your pretax income. These deductions are contributed to a tax-deferred retirement account. For 2008, you may contribute up to $15,500 for most defined-contribution plans ($20,500 if age 50 or older).
Emergency Fund: An emergency fund is also called a rainy-day fund. It is your pool of savings that is parked in a safe and liquid savings instrument (perhaps even under the mattress) so that you can access the funds in an emergency. Financial planners recommend that you have an emergency fund that is equal to between three and six months of your salary. Major reasons for tapping your emergency fund include losing a job or incurring large and unexpected medical expenses.
Encryption: A process that electronically scrambles data with algorithms, or complex mathematical formulas. The algorithms ensure that data are securely transmitted across public data networks such as the Internet. Encryption requires a de-scrambling device at the receiving end of the transmission. The de-scrambler restores the data to a state that can be understood. Encryption with the current industry-standard 128-bit technology reduces to near zero the possibility of unauthorized access to the data.
Equity: Real estate: the residual ownership claim on a home's value. Equity equals the fair market value of a home, less any mortgage debt or other obligations. Stocks or businesses: an ownership stake in a company. Shareholders equity is equal to assets minus liabilities.
Establishing Credit: Establishing credit is the act of beginning your own credit history. Establishing credit requires you to apply for a credit card or other loan, such as an auto, student, or personal loan. To apply for a credit card for the first time, you may wish to consider a secured credit card. This kind of card requires that you deposit an amount equal to how much you are allowed to borrow with the card. Another way of establishing credit is to obtain a co-signature from a parent or relative that guarantees the debt. If you lack either of these choices, you should have a verifiable source of income. Finally, you should avoid becoming delinquent in your payments. This means paying at least the minimum amounts due by the due date.
Estate: Your estate is the value of your assets minus allowable deductions at your death. Good estate planning ensures that the proceeds of your estate are distributed to your desired beneficiaries. This requires that you draft a will or trust and update it periodically. Poor estate planning leads to probate, a lengthier and more expensive process of determining the distribution of your estate. Probate may also result in a larger bill for estate taxes.
Estate Planning: Estate planning is the set-up and administration of your estate to ensure that your desired beneficiaries are provided for. You use a will or trust to name your beneficiaries and expedite the settlement of your estate when you die. Estate planning has significant tax consequences. For 2008, the applicable exclusion limit is $2 million and the maximum estate tax rate is 45%.
Estate Taxes: Estate taxes are levied on the beneficiaries, or heirs, of an estate. For 2008, the amount of income that is excluded from estate taxes is $2 million. The maximum estate and gift tax rate is 45%. The exclusion rises to $3.5 million in 2009. The 2001 tax law eliminates the estate tax in 2010. The maximum gift tax rate in 2010 will be 35%.
Excess Accumulation: Excess accumulation occurs when you take less than the required yearly amount (required minimum distribution) from a regular IRA. You may be subject to an excise tax of 50% of the amount you did not withdraw.
Executor: The person who sets up a trust for the distribution of his or her assets. Also known as a grantor.
Expected Rate of Return: Expected rate of return is the return that you expect to earn on an investment, stated as a yearly percentage. For example, a $10 stock that is expected to be worth $10.80 in one year has an expected rate of return of 8%.
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Fair Credit Reporting Act (FCRA): The Fair Credit Reporting Act is a federal law passed in 1970 that protects consumers from abusive credit reporting practices. Among its statutes, the law authorizes you to receive a free copy of your credit report within 60 days, if denied credit by a lender that based its decision, in part, on information in your credit report. FCRA was amended in 2003 with the passage of the Fair and Accurate Credit Transactions Act which provides for a free credit report annually from each of the major credit bureaus.
Fed Funds Rate The fed funds rate is the interest rate that major U.S. banks charge each other to borrow money on a short-term basis. Usually, this is for loan terms of one day (overnight borrowing) to one week. The Federal Reserve sets a target rate, and adds or drains reserves to the money supply to reach it. Although the fed funds rate is a short-term rate, a change in its target level by the Fed sends a strong message to the bond market of its intent to fight inflation. As a result, long-term interest rates are also affected by a change in the target rate.
FICA FICA is an acronym for the Federal Insurance Contributions Act, otherwise known as Social Security. FICA consists of Old Age Survivors and Disability Insurance (OASDI) and Medicare. For 2008, you pay OASDI taxes at the rate of 6.2% on your first $102,000 in income. You pay Medicare taxes at the rate of 1.45% on all income. Together, the FICA tax is equal to 7.65% for the first $102,000 of income. Your employer makes a matching contribution. Together, this equals a combined rate of 15.3%.
Financial Goal: A financial goal is a goal that involves saving and investing to reach a specific amount by a specific date. For example, a financial goal may be to save $25,000 for a college education fund for a child in 15 years, or it may be to save $500,000 for a retirement fund in 25 years. You can achieve your financial goals through a combination of saving more, saving longer or earning a higher rate of return.
401(k) Plan: A 401(k) plan is a defined-contribution plan that permits employees to have a portion of their salary deducted from their paycheck and contributed to an account. Federal (and usually state) taxes on the employee contributions and investment earnings are deferred until the participant receives a distribution from the plan (typically at retirement). Employers may also make contributions to the account of a participant. For 2008, you may contribute up to $15,500 to a 401(k) plan. If you are age 50 or older, you may contribute an additional $5,000, or a total of $20,500. If your employer makes contributions, the most that may be contributed (including forfeitures) to a 401(k) plan for 2008 is the lesser of $46,000 ($51,000 if age 50 or older) or 100% of your compensation.
403(b) Plan: A 403(b) plan is a defined-contribution plan that lets you make tax-deferred contributions to your own retirement account. Employees of universities and non-profit organizations use a 403(b) plan. A 403(b) plan is funded through regular payroll deductions called elective deferrals. Your contributions are eligible for matching contributions by your employer. For 2008, you may contribute up to $15,500 to a 403(b) plan. If you are age 50 or older, you may contribute an additional $5,000, or a total of $20,500. If your employer makes contributions, the most that may be contributed to a 403(b) plan for 2008 is the lesser of $46,000 ($51,000 if age 50 or older) or 100% of your compensation.
457 Section Plan A Section 457 plan is a retirement plan for employees of state and local governments that is used instead of a 401(k) or 403(b) plan. For 2008, you may contribute up to $15,500 to a 457 plan. If you are age 50 or older, you may contribute an additional $5,000, or a total of $20,500. If your employer makes contributions, the most that may be contributed to a 457 plan for 2008 is the lesser of $46,000 ($51,000 if age 50 or older) or 100% of your compensation.
Frequent Flier Miles Card: A frequent-flier-miles card, or flight card, is the most widely used type of reward card. You earn miles, or points, for each dollar in purchases. When you earn enough points, you redeem them for a free airline ticket or upgrade with the participating airline. Terms vary across reward programs. For example, some programs have travel "black-out" dates. Others require more miles or points in order to earn a free ticket.
Future Value: The future value is the amount that your investment grows to in the future. For example, the future value of $100 invested at 8% at the end of each month is $1,245 after 12 months. The present value, or value of this future value in today's dollars, depends on the discount rate. Often, the discount rate used is the same rate as the rate of return, or 8%. The present value of $1,245 discounted at 8% is $1,153. If you were to invest $1,153 today at 8%, this would grow to $1,245 in one year. In other words, you can invest $100 a month for the next 12 months or $1,153 today to obtain the same future value.
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Generation Skipping Tax (GST): Generation-skipping tax (GST) is owed on the value of an estate that is bequeathed to a grandchild, great-grandchild or other non-consecutive generation of heirs. For 2008, every individual can exempt up to $2 million from the GST. Like the estate tax, the GST is phased out over the next several years.
Gift Splitting: Gift-splitting is the process of allocating a gift among spouses in order to take advantage of the gift-tax exclusion. If you split a gift, the IRS requires you to complete IRS Form 709 for the tax year in which you made the gift.
Gift Tax Exclusion Limit: The gift-tax exclusion limit is the amount that is exempt from gift taxes. For 2008, the limit is $12,000.
Gift Taxes: Gift taxes are paid by the benefactor (also called the donor or giftor). A gift tax is levied on amounts that exceed a yearly per-person exclusion of $12,000. The maximum gift tax rate is 45% in 2008. The maximum gift tax rate drops to 35% in 2010.
Gifting: Gifting is the process of distributing your wealth to designated beneficiaries. Gifting is essentially giving except that the process has a legal connotation since it ultimately affects the value of your estate. Gifting involves a benefactor (also called the donor or giftor) transferring, or gifting, cash or other property to a beneficiary (also called the donee or giftee).
Grace Period: For credit cards, the grace period is the number of days a card company allows you to pay for a charge without paying interest. If you do not pay during the grace period, you will begin to pay interest. Most card companies in the U.S. have a grace period of between 20 and 25 days. For student loans, grace period is the number of months after you graduate or leave school that the lender allows you to defer loan payments. When the grace period ends, you must begin to repay the loan.
Grantor: The person who sets up a trust for the distribution of his or her assets. Also known as an settlor.
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Hard Inquiries: Requests by creditors for a copy of your credit report to assist in making a credit decision. Hard inquiries are tallied on your credit report. In general, it is considered prudent to avoid applying for too much credit. Too many applications result in excessive inquiries. Too many inquiries are often seen as a sign of potential trouble. Lenders are more willing to overlook a flurry of inquiries that coincide with your purchase of a big-ticket item, such as a car or home.
Health Condition Questionnaire: A questionnaire that surveys your health history and is used to determine the cost of a life or long-term care insurance premium for you. You are required to accurately disclose your condition, including pre-existing conditions. If you fail to accurately disclose your medical condition, the insurer generally has the right to cancel your policy within a given period.
Hedging Hedging is a risk management technique that eliminates future price uncertainty. To hedge, you pay a price today that reflects expectations of buyers and sellers for the future price of a commodity, index, foreign currency or other financial asset. Hedging helps you to limit your losses but also limits your chances of earning a higher rate of return. A foreign exchange hedge is a technique of locking in a future exchange rate today.
Heir: An heir is the beneficiary of an estate.
Home Equity Loan: A home equity loan is a mortgage loan that is secured by the residual equity in your home. To calculate equity, subtract mortgage debt from your home value. Home equity loans allow a homeowner to make repairs or other home improvements, refinance other debt, or use for general purposes. Unlike a home-equity line of credit, a home equity loan is an amortizing loan.
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Icon: A graphical image used to identify or execute a function for a Web site. A padlock or similar icon is often used to identify the page of a site that uses Secured Socket Layers (SSL) or similar technology. SSL is generally used to process online applications and transactions.
Income Limits: For some tax breaks, the IRS imposes a limit on how much income you can earn in a year. Usually, this is a range of income with a lower and upper limit. For purposes of defining income, modified adjusted gross income (MAGI) is generally used. When your income reaches the lower limit, your tax break is reduced, or begins to phase out. When your income reaches the upper limit, your tax break is eliminated, or is completely phased out.
Income Tax Bracket: Income tax bracket is the highest range of taxable incomes on which you pay income taxes. The Economic Growth and Tax Relief Reconciliation Act of 2001 cut tax rates for all individual income tax brackets except the 15% bracket. A sixth tax bracket of 10% was added for the first $6,000 ($8,025 in 2008) of income for single taxpayers, $10,000 ($11,450 in 2008) for single parents, and $12,000 ($16,050 in 2008) for married taxpayers. Income tax rates for 2008 are 35%, 33%, 28%, 25%, 15%, and 10%. For 2008, the 25% tax bracket for single taxpayers is for taxable incomes between $32,550 and $78,850. For married taxpayers filing jointly, the same tax bracket is for taxable incomes between $65,100 and $131,450. See the IRS Web site for all 2008 income tax brackets.
Increased Contributions to Retirement Plans: The Economic Growth and Tax Relief Reconciliation Act of 2001 authorizes higher yearly contribution limits to IRAs, 401(k) plans, and other defined-contribution retirement plans. For 401(k) plans, the yearly limit increases to $15,500 in 2008. A catch-up provision of the new law authorizes even higher limits for workers who are age 50 or older. For these employees, the yearly limit increases to $20,500 in 2008. Beginning in 2007, employees participating in a 401(k) plan may able to open a Roth 401(k) within the plan account. Employees can maintain a traditional 401(k) and Roth 401(k), but combined yearly contribution limits will be $15,500 ($20,500 for employees over 50).
Index Rate: An index rate is a widely used interest rate that lenders use to set the interest rate on loans and credit cards. For residential mortgages, 10-year U.S. Treasury securities are often used for 30-year fixed-rate loans (on average, most homeowners live in their homes for a period of time closer to 10 years than 30 years). For ARM loans, a common index is the Eleventh District Cost of Funds Index (COFI), published by the San Francisco-based district office of the Federal Home Loan Bank. For credit cards, the U.S. commercial prime rate is frequently used as an index rate.
Indexing: Indexing is a process of adjusting amounts periodically to reflect an increase in the inflation rate. The IRS frequently indexes dollar amounts for taxable income, contributing to tax-advantaged retirement accounts and taking tax deductions. Indexing is also a process of determining loan interest rates. It involves setting an interest rate to a base rate, usually a widely quoted market rate such as the yield on U.S. Treasury bills, LIBOR or the U.S. prime rate. Indexing allows a lender and borrower to share the risk of changes in the base rate. The base rate is reset occasionally, such as on specific date every year or other interval. The amount added to the base rate is called the margin, or spread.
Individual retirement account (IRA): The two main types of IRAs are regular and Roth IRAs. Regular IRAs are also called traditional IRAs because they were the first IRAs introduced back in 1981. Roth IRAs were introduced in 1998. Regular IRAs allow you to make a tax-deferred yearly contribution of $5,000 in 2008. For persons who are age 50 or older, a special catch-up provision allows you to contribute an additional $1,000, or a total of $6,000, for 2008. This account grows tax-deferred until you begin to take distributions, which you can do after you turn age 59-1/2. Roth IRAs require you to pay income taxes in the year that you make the contribution. You also can contribute $5,000 per year in 2008 ($6,000 if age 50 or older). Roth IRAs grow tax-deferred, and if you keep the account for at least five years and are at least 59-1/2, the entire account can be distributed tax- and penalty-free.
Inflation: Inflation is a general increase in prices that you pay for goods and services, stated as a yearly rate. If the inflation rate is 4%, it means that prices increase at a yearly rate of 4%. For example, the same basket of goods and services that you can buy today at $1,000 will cost you $1,040 next year. Inflation cuts into your purchasing power even further for longer periods. For example, if you have $100,000 today and inflation grows at 4%, it would be worth $82,193 in five years. After 10 years, it would be worth $67,556. The major inflation indexes are updated monthly by the U.S. Department of Labor. The first index is the wholesale price index. It is also called the producer price index (PPI). PPI measures inflation that manufacturers and other producers face. The second index is the consumer price index (CPI). CPI measures inflation that consumers face for goods and services such as food, fuel, and housing. Monthly PPI and CPI figures are reported as a percentage change over the previous month. A series of 12 monthly reports are linked to determine a yearly inflation rate.
Interest Rate: Interest rate is the cost of borrowing money as a yearly percentage. For investors, interest rate is the rate earned on an investment as a yearly percentage. The simple interest rate is interest paid or received divided by loan or deposit. For example, $100 in annual interest on a $1,000 loan or deposit is a simple interest rate of 10%. Compounded interest rate is determined by the frequency of interest payments during the loan or deposit term. For example, a 10% loan or deposit that is compounded quarterly equals a compounded rate of 10.38%. If compounded daily, the compounded interest rate increases to 10.52%. (For CD investors, compounded interest rate is called annual percentage yield.) Effective interest rate, or annual percentage rate (APR), is the true interest cost of borrowing. It includes fees and points you pay for a loan in the calculation. As a result, effective interest rate is higher than simple interest rate.
Interest Rate Risk: From an investor point of view, interest rate risk is the likelihood that interest rates will rise, causing the value of your bonds and other fixed-income securities to drop. From a consumer point of view, it is the risk that your borrowing cost on a variable-rate loan will rise.
Introductory Rate: An introductory rate is the discounted interest rate you receive during an introductory period of using a new credit card. Introductory rates are sometimes called "teaser" rates. They are low to encourage you to obtain a new credit card and make new charges.
Investment Objective: A mutual fund defines its investment objective in its prospectus. It is how much risk the fund is willing to accept in exchange for a higher rate of return. It also defines the types of investments it can make, how much debt it can assume and any other controls. Major investment objectives of stock mutual funds include growth, value and income. Fund data research companies often compare funds by investment objective to evaluate their relative investment performance.
Investment Performance: Investment performance is a report card of the rate of return of a mutual fund or other investment. Rates of return are often shown for several periods of time. If available, investment performance may be shown for a period of up to 10 years. For example, investment performance of Mutual Fund XYZ may show that the fund earned an annualized rate of return of 3% for a three-month period, 5% for a six-month period, and 10% for a 12-month period.
Investment Profile: Investment profile is a composite sketch of your financial goals, risk tolerance and investment horizon.
Investment Return: Investment return is the gain or loss on an investment, stated as an annual percentage rate. Investment returns for periods of more or less than a year are annualized. Annualizing is the process of converting returns to a one-year period. Investment returns for multiple-year periods are generally average annual returns.
Investment Risk: Investment risk is the probability that your investment will lose value. It is measured by the volatility of investment returns. If the rate of return of a stock or other security moves up and down over a wide range, the stock is said to have more investment risk than one whose returns fluctuate less. For example, a stock you bought for $10 that fluctuates between $16 and $2 over the next year has more risk than if its price fluctuates between $12 and $8. You can reduce risk to a large degree by holding a diversified portfolio of investments.
IRA Account Balance: IRA account balance is the amount of the regular IRA at the end of the preceding year, adjusted for certain contributions and distributions. The IRA account balance is used to calculate required minimum distributions (RMDs).
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Joint and Survivor Annuity Option: A joint-and-survivor annuity option is a benefit that you pay for separately. It provides continuing benefits after you die to the beneficiary until the beneficiary dies.
Judgment: A judgment is a legal ruling that requires a defendant to pay a sum of money to the plaintiff as compensation. A judgment may impose a lien, or legal claim, on the assets of the person or organization that the judgment has ruled against. One way to collect a judgment is the garnishment of wages to pay a creditor.
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Keogh Plan: A Keogh plan is a defined-contribution retirement plan for self-employed persons and their employees, including sole proprietorships and partnerships. For defined-benefit plans for 2008, employers may contribute up to an amount that would fund a pension of the lesser amount of $185,000 or 100% of the average compensation for an employee over his or her highest consecutive three-year period. For defined contribution plans for 2008, employers may contribute up to the lesser amount of $46,000 ($51,000 if age 50 or older) or 100% of compensation, subject to an annual compensation limit of $230,000. For 2008, you may contribute up to $15,500 to a qualified 401(k) plan. If you are age 50 or older, you may contribute an additional $5,000, or a total of $20,500.
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Laddering: An investing strategy that allows you to earn interest on your most-prized savings without sacrificing your access to them. You invest in term deposits or bonds that have staggered maturities. For example, this may be 6-month, 1-year, 3-year, and 5-year CDs. As each deposit matures, you roll over the principal and accrued interest for a term that coincides with when you need the funds. This allows you to have the funds available quickly, earn interest, and avoid paying a penalty for ending a term deposit before maturity.
Leveraging: Leveraging is a process of borrowing at a lower interest rate and investing the funds at a higher rate of return. Leveraging is often a risky process. A low borrowing cost, for example, can increase unexpectedly. Your lender may suddenly expect you to be a greater credit risk. Also, your investment rate of return can decrease suddenly.
Lien: A lien is a legal claim held by a creditor against an asset to guarantee or secure repayment of the debt. Mortgage liens are regularly used in real estate lending as collateral for a loan.
Life Expectancy: Your life expectancy is the number of years that you are expected to live, statistically. Your life expectancy is based on the actual life span of the same set of population that shares similar risk characteristics. These risk characteristics include smoking and drinking habits, level of exercise, and hereditary or congenital health problems. Life expectancy is used to calculate life insurance premiums and required minimum distributions from IRAs, among other reasons.
Liquidity: Liquidity is a favorable characteristic of a stock, bond or other security. It represents the relative ease with which a security may be sold. The more buyers and sellers there are for a security, the greater its liquidity. Liquidity is often reflected in the spread of the price of the security: A narrow spread between bid and ask prices is a positive sign of liquidity.
Living Will: A will that you execute while you are still living that can be revoked or modified as you determine appropriate.
Loan Payoff: A loan payoff is a payment that you make on a loan or other debt to remove the entire amount owed. A loan pay-down, in comparison, is a payment that you make on a loan or other debt to reduce the amount owed.
Loan Pay Down: A loan pay-down is a payment that you make on a loan or other debt to reduce the amount owed. A loan payoff, in comparison, is a payment that you make on a loan or other debt to remove the entire amount owed.
Long Term Care (LTC) Insurance: An insurance policy that pays benefits for skilled care and personal care assistance to the insuree that is necessary to cope with normal living activities such as eating, toileting and dressing.
Lump Sum Distribution: A lump sum distribution is the distribution or payment, within a single tax year, of a plan participant's entire balance from the employer's qualified plan (pension, profit sharing or stock bonus plans). If the participant has more than one account in any category, all the accounts must be distributed.
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Market Interest Rate: Market interest rate is the interest rate for bonds with similar risk characteristics and terms to maturity to those of the bond you are selling. The market interest rate is useful for indicating the price of your bond. If the market interest rate is lower than the coupon rate of your bond, your bond price will be at a premium to its face value. If the market interest rate is above the coupon rate of your bond, your bond price will be at a discount to its face value.
Market Value: Market value is the value of an asset as of a certain date. It is the price that the asset would exchange hands in a free and arms-length transaction. Market value is also called current value. For example, the market value of your retirement account today may be $100,000. This is the total market value of the stocks, bonds, cash and mutual funds in your account. In the case of most securities, market values can be determined every day, even at a given point in time. For less-liquid assets, such as real estate or collectibles, market value may require a professional appraisal.
Margin: Margin has different meanings for different industries. For mortgage lending, margin is the amount a lender adds to the base rate of an adjustable-rate mortgage or other variable-rate loan to set the loan rate. For example, if a one-year ARM loan has a margin of 300 basis points over the yield on 1-year Treasury bills and the T-bill yield is 6.5%, the loan rate is set to 9.5%. For brokerage accounts, margin is the deposit required by an investor who short-sells a stock (i.e., borrows shares from a broker and sells the shares, hoping to buy them back at a lower price and return the borrowed shares.)
Marginal Benefit: Marginal benefit is rooted in cost-benefit analysis. It is the incremental benefit received from consuming one additional unit.
Marital Deduction: Marital deduction is the conveyance of estate from a spouse who has died (the decedent) to the surviving spouse. Federal estate tax law allows you to transfer your entire estate to the surviving spouse with no estate tax liability.
Matching Contribution A matching contribution is one where the plan sponsor, usually the employer, matches employee contributions to a 401(k) or other qualified retirement plan. A partial matching contribution is one where the plan sponsor matches less than $1 for each $1 that the employee contributes to his or her own account. A fully matching contribution is one where the plan sponsor matches $1 (or more) for each $1 that the employee contributes.
Maturity: Loans: Maturity is the end of a loan term when the full amount of the loan is repaid in full to the lender. Bonds: Maturity is the date that the face value of the bond is repaid to investors. If the face value is less than the price the investor paid, the bond investor earns a capital loss. (This is equivalent to saying the investor bought the bond at a premium to face value.) The bond investor may have earned enough in coupon interest to make it a profitable investment, however. If the face value exceeds the price the investor paid, the bond investor earns a capital gain. (This is equivalent to saying the investor bought the bond at a discount to face value.)
Means Test: A test administered by the Social Security Administration to determine if the amount of income and assets that you own are enough to pay for the cost of a service that a federal program such as Medicaid would otherwise pay for.
Medicare: Medicare is the federal health insurance program for persons who are eligible to receive Social Security benefits. As a general rule, you can apply for Medicare when you turn age 65. In some cases, you may be eligible for Medicare at a younger age. Part A of Medicare is the hospital insurance (HI) component. Your entire FICA contribution goes toward Part A. Part B of Medicare is called the medical insurance component. You purchase Medicare insurance for Part B, which covers physician and outpatient expenses.
Medicare Supplemental Insurance (Medigap): Medigap insurance is health insurance sold by private insurance companies to plug gaps in coverage not provided by Medicare, the federal health insurance program for senior citizens and other qualified persons. Medigap insurance is also called Medicare Supplement Insurance.
Medicare Taxes: Medicare taxes are paid to the Medicare (HI) fund. For 2008, you pay 1.45% of your income, regardless of limit, as Medicare taxes. Your employer pays the same percentage. If self-employed, you pay 2.9% in Medicare taxes.
Merchandise Rebate Card: A rewards card that gives the cardholder a discount on branded merchandise for each dollar in purchases. There is a yearly limit to the size of rebate that can be earned in a year.
Modified adjusted gross income (MAGI): Modified adjusted gross income (MAGI) is a measure of income used to determine how much of a tax-deductible contribution you may make to a regular IRA or nondeductible contribution to a Roth IRA. MAGI is also used to determine how much you can contribute to certain Coverdell education savings accounts, formerly called education IRAs. MAGI is smaller than gross income and may be larger than adjusted gross income (AGI is shown on line 37 of the 2007 IRS Form 1040.) The IRS says that MAGI and AGI are equal for most taxpayers. To calculate MAGI, add any foreign-earned income and housing exclusions (or income earned in American Samoa or Puerto Rico) to your AGI.
Money Market Account (MMA): A money market account is a bank account that invests in the safest of short-term securities. Opening a money market account generally requires a larger deposit than a checking account since it pays a higher interest rate than demand deposits. The FDIC insures money market accounts for up to $100,000 per institution per depositor.
Money Market Mutual Fund: Mutual funds that invest in the safest of short-term securities may not keep pace with inflation. These include Treasury bills, commercial paper (CP), and other short-term debt securities. Mutual funds are responsible for picking the investments that make up the mutual fund. The F.D.I.C. does not insure money market mutual funds.
Money Purchase Pension Plan: A money-purchase pension plan is a defined-contribution plan in which contributions from the employer are determined by a specific formula, usually as a percentage of pay. Contributions are not dependent on company profits (Source: Profit Sharing 401k Council of America).
Mortality & Expense (M & E) Fees: Mortality and expense fees are yearly fees that an annuity contract owner pays to the life-insurance company that sold the contract. M & E fees average about 1.25% of the value of a contract. M & E fees are to pay for adjustments the insurer faces in the risk of its pool of insurees.
Mutual Fund: A mutual fund invests in a portfolio of stocks, bonds or other investments and sells individual shares of the portfolio to investors. Mutual funds have been around since the 1920s and regulation of their activities was beefed up in the 1940s. Mutual funds earn income on their investments and are required to pass most of it through to their shareholders each year. Income is earned as interest, dividends or capital gains. Capital gains are the profits earned on the actual sale of securities in the portfolio. There are two main types of mutual funds: open- and closed-end funds. Most funds fall into the first category. An open-end fund buys and sells its shares at the net asset value of the fund. A closed-end mutual fund sells a limited number of shares, which usually trade on a stock exchange. Shares of closed-end funds routinely trade at a discount or premium to NAV.
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Net Income: Individuals: Net income is the amount of income left after all deductions and taxes. Corporations: Net income is a company's profit for a given period of time after it pays taxes and all other expenses.
Net Present Value (NPV): Net present value is a method of determining the value of an investment in today's dollars. To calculate net present value, you discount future cash flows at the appropriate interest rate. You subtract your cash outlay from the sum of the present value of your cash inflows to determine your net present value. As a general rule, if net present value is positive, the investment should be made.
Net Unrealized Appreciation: The increase in the value of shares held in a custodial account that occurs prior to the employee taking a distribution of the shares. The employee can elect to defer income taxes on this appreciation until he sells the shares, or pay taxes in the year he receives the distribution. The amount of net unrealized appreciation is taxed at the long-term capital gains tax rate, up to the amount of the appreciation.
Non-elective Contributions: An employer that contributes to a SIMPLE-IRA plan for its employees may choose to make elective or non-elective contributions. Elective contributions are for 3% of compensation of the employee, up to $6,900 for 2008. Elective contributions are matching contributions, which means that they are made if the employee makes salary-reduction contributions. Non-elective contributions are for 2% of compensation of the employee, up to $4,600 for 2008. Non-elective contributions are made whether or not the employee makes salary-reduction contributions.
Nondeductible Contributions: A nondeductible contribution is the portion of a contribution to a regular IRA that is not tax-deductible. Your tax-deductible contributions phase out at higher incomes. Adding deductible and nondeductible contributions, you are still allowed to contribute up the yearly limit of $5,000 in 2008 ($6,000 if age 50 or higher).
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Old Age Survivors and Disability Insurance (OASDI): Old Age Survivors and Disability Insurance (OASDI) is the official name of the basic retirement benefits portion of the Social Security program. The program is funded from Social Security (OASDI) taxes. For 2008, the contribution to OASDI is 6.2% of the first $102,000 of income. Employers must make a matching contribution, which raises the combined contribution per worker to 12.4% of the first $102,000 in income.
Open End Credit: Open-end credit is also called revolving credit. It is a loan or other form of credit that allows the borrower to use as long as he or she does not exceed a credit limit. This means that the borrower can pay down the loan and borrow again at will.
Opportunity Cost: Opportunity cost is the sacrifice of benefits from the next-best alternative that you face when you make a financial or economic decision. For example, say you had $1,000 to invest. You could invest it in a stock mutual fund that might return 20% or more. If you make this investment decision, you sacrifice the opportunity to earn a lower rate of return on an investment that has no risk. This might be a CD or other fixed-term deposit that had a 6% rate of return. This 6% guaranteed return would be the opportunity cost of investing in the mutual fund instead.
Over The Limit Fee: An over the limit fee is charged to a credit card user when he or she charges more than the credit limit. If you have a personal or home-equity line of credit, and charge more than your credit limit, you are likely to pay an over-the-limit fee.
Overdraft Privilege: Overdraft privilege is a service a bank offers certain customers to temporarily borrow or borrow more than an authorized credit limit. In most cases, if the customer makes a sufficient deposit the same day, the fee for this privilege is waived. If not, the customer is charged an interest rate for what is essentially a short-term loan.
Outperformance: Outperformance is used to describe the relative investment performance of stocks, bonds and other securities to each other and to their respective benchmark indexes. For security analysis, an analyst may issue an outperform recommendation for a given stock if he or she expects the stock will earn a higher rate of return than its benchmark index or peer firms.
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Pay Period Frequency: Pay periods are daily, weekly, bi-weekly (26 periods in a year), semi-monthly (twice a month), monthly, quarterly, semi-yearly (twice a year), and yearly. Most pay periods are bi-weekly, semi-monthly, or monthly. If you choose weekly, multiply by 4 to approximate monthly pay. If you are paid twice a month or every two weeks, multiply by 2 to approximate monthly pay.
Pension Plan: A traditional pension plan is an employer-sponsored retirement plan that pays retirees a fixed amount that is based on number of years of service and salary history. The employer is liable for the full amount of the plan. Traditional pensions are defined-benefit plans and are guaranteed by the PBGC. Employer-sponsored retirement plans such as 401(k), 403(b) and 457 plans are called defined-contribution plans. Defined-contribution plans are funded, in large part, on employee contributions. As a result, these plans are not guaranteed by the PBGC.
Periodic Interest Rate: The periodic interest rate is the fractional amount of an annual interest rate. It is used to calculate interest for a period shorter than a year. For example, if you calculate interest on a 360-day year, you have 12 billing periods of 30 days each. If the annual interest rate is 8%, the periodic rate for one month is 0.67% (.08/12). The periodic interest rate for one day is 0.022% (assuming a 360-day year).
Personal Assets: Personal assets are those assets that belong to you. In general, an asset is property that has value. It can be sold or used up over a period of time. The value of an asset is stated in dollars (or the appropriate currency). Personal assets include checking and savings accounts, investments, personal property, real estate, collectibles, and the value of life insurance policies. In order to place a value on personal assets, you rely on either market value of appraisal value. For assets that are liquid (i.e., there are many buyers and sellers of the asset or a close substitute), market value is a reliable indicator. For assets that are illiquid (such as a collectible), appraisal value is a more reliable indicator.
Personal Balance Sheet A personal balance sheet shows your personal assets and personal liabilities. A personal balance sheet may be displayed using a t-account, with assets on the left and liabilities and equity on the right. Or it may be displayed in a stacked fashion, with assets on top and equity on bottom.
Personal Bankruptcy: A person files for personal bankruptcy if they are unable to pay their bills. You file for personal bankruptcy under either Chapter 7 or Chapter 13 of the U.S Bankruptcy Code. Under the terms of a Chapter 7 filing, which is administered by a bankruptcy trustee, you are usually required to sell your home and car to fulfill any debt obligations. Unsecured debts are generally forgiven. The other type of personal bankruptcy filing is a Chapter 13 filing. A Chapter 13 filing consists of a trustee establishing a debt repayment plan. You are not required to sell your home or car under a Chapter 13 filing. With personal bankruptcy, you may have certain debts forgiven. Your bankruptcy filing remains a public record for ten years.
Personal Budget: A planning tool that lays out in simple and concise terms how much you earn and spend each month. For example, you may decide to spend $1,000 and save $200 from your monthly after-tax income of $1,200. You can do a personal budget for the entire household. As part of the budgeting process, you want to save for several months of emergency, or rainy day, expenses. These are funds you can live on for three to six months in the event of an emergency. Part of setting up a personal budget is using it to compare to your actual spending. If you actually spend $1,100 a month and save only $100, you either need to discipline your spending, or adjust your budget to more realistic circumstances.
Personal Care: A level of care that helps a person perform activities of daily living, or ADLs, and that can generally be provided at home.
Personal Cash Flow: The difference in cash inflows and outflows over a period of time. Calculating your personal cash flow is an essential part of personal budgeting. Cash inflows include salary and other sources of cash-based income. Non-cash compensation is excluded, and you should deduct any contributions to a retirement account. Cash outflows include bill payments, including mortgage or rent, living expenses, utilities, and repayment of debt. Personal cash flow is usually measured over a monthly period.
Personal Liabilities: Personal liabilities are your debts and obligations. The amount of liability you owe is stated in dollars (or the appropriate currency). Personal liabilities most commonly consist of loans, including those you may have cosigned or guaranteed. (Liabilities for which you are liable in the event of default by the main borrower are called contingent liabilities.) Major categories of personal liabilities include credit card debt, installment debt, mortgage and home equity debt, and brokerage accounts where you have a margin account.
Personal Line of Credit: A personal line of credit is an unsecured line of credit that may or may not have a personal guarantee. A personal line of credit is a form of revolving credit. This means you can borrow an amount up to but not exceeding a pre-approved credit limit. Unlike a personal loan, payments are flexible and may consist of interest-only payments.
Personal Net Worth: Your personal net worth is equal to your personal assets minus personal liabilities. Personal net worth is measured as of a given date (e.g., "Your personal worth is worth this much as of Dec. 31, 2008."). For example, if you have $100,000 in personal assets and $75,000 in personal liabilities, you have $25,000 in personal net worth. Since the value of your assets fluctuates, your personal net worth will fluctuate. For example, six months later on June 30, your personal assets may have risen in value to $110,000. In this case, your personal net worth has also increased by $10,000 to $35,000. If you are married, consider computing a combined personal net worth, or splitting the value of jointly owned assets in two. If you have more assets than liabilities, you have a positive personal net worth. Personal net worth is also called personal equity.
Phase Out: The IRS regularly uses income limits to limit the use of tax breaks at higher incomes. These income limits consist of a lower and upper limit. The tax break begins to be reduced, or partially phased out, at the lower limit. The tax break is eliminated, or completely phased out, at the upper limit. Income limits and phase-out amounts for tax breaks are generally indexed to inflation.
Policyholder: The policyholder is the insured person who buys an insurance policy for the benefit of a beneficiary. The policyholder is also called the insuree.
Portfolio: A portfolio is a group or securities or other investments. If you invest in a diversified portfolio of securities, you can generally reduce your investment risk. (Investment risk is the volatility of investment returns of the securities in your portfolio.) A diversified portfolio lets you to earn a higher rate of return for a given amount of risk or reduce your risk for a given rate of return.
Power of Attorney: A legal document that authorizes your appointment of a trustee to act as your legal representative if suffering a debilitating illness.
Pre-existing Condition: A pre-existing condition is a medical condition that was incurred prior to obtaining medical coverage provided under a health insurance policy. The Health Insurance Portability and Accountability Act (HIPAA) regulates group health plans' use of exclusions of pre-existing conditions as a means of increasing equitable coverage by group health plans.
Premium: Insurance: The amount an insurance policyholder pays periodically to maintain insurance coverage. Bonds: A price more than the face value of the bond. A $1,000 bond that trades for $1,050, for example, trades at a premium of $50.
Premium Insurance: The amount an insurance policyholder pays periodically to maintain insurance coverage. Bonds: A price more than the face value of the bond. A $1,000 bond that trades for $1,050, for example, trades at a premium of $50.
Present Value: Present value is the value of a future payment, or series of payments, discounted at the appropriate interest rate to determine the value in today's dollars. For example, if you were given the choice of $100 today or a year from now, you would choose to take it now. You can invest or spend it. If you could invest it at 10%, you would have $110 a year from today ($110/$100). In other words, the present value of $110 a year from today is $100 if the discount rate is 10%. The discount rate should be at least equal to the inflation rate, which has averaged about 3% a year over the last decade. As a result, $103 a year from now has a present value of $100 ($103/1.03).
Previous Balance Method: A method occasionally used by banks to calculate the interest due on a credit card or other form of open-end credit, such as a home equity line. Unlike the average daily balance method, which uses your most recent billing period, this method uses the previous billing period. To calculate average daily balance, add your daily balances for each day in a billing period, which is usually 30 days. Divide by the number of days in the billing period. The result is your average daily balance. The lender multiplies this by the periodic interest rate to calculate how much interest you owe for the month. For example, if your total of daily balances equals $30,000 for a 30-day period, your average daily balance is $1,000. If the periodic interest rate is 12 percent (1 percent for one month), your interest expense would be $10.
Privacy Policy: A privacy policy is a concise and easy-to-find statement at the Web site of a financial institution that defines the terms and conditions of how, when and in what way the firm may use your personal data. A privacy policy should include a disclaimer or promise to not share data with parties that you have not authorized. Often, a privacy policy will also address the use of "cookies" by the firm. A cookie is a file that is stored on your personal computer to easily identify you.
Probate: Probate is a legal procedure settled by a state court of law that identifies the heirs to your estate and determines their legally entitled share. Probate is time consuming and expensive with costs often ranging between 6 and 10 percent of the value of your estate, according to the National Association of Financial & Estate Planning.
Profit Sharing Plan: A profit-sharing plan is a deferred compensation plan that an employer offers its employees. The employer makes contributions to employee retirement accounts that are based on its profits. Profit-sharing plans and money-purchase pension plans are the two types of qualified plans used by small businesses.
Prospectus: A prospectus is a document that a mutual fund, annuity or company selling shares to the public is required to file with the Securities and Exchange Commission. The prospectus spells out details of a mutual fund or stock offering to the investing public. Mutual fund companies are required to send all potential investors a copy of the fund prospectus.
Purchase Payment: A purchase payment is the money you pay to buy an annuity contract from a life insurance company. A single purchase payment is a lump sum amount. A multiple purchase payment includes additional purchase payments.
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Qualified Plan: A qualified plan is a retirement plan for self-employed persons and their employees, including sole proprietorships and partnerships. For defined-benefit plans for 2008, employers may contribute an amount that would fund a pension of up to the lesser amount of $185,000 or 100% of the average compensation for an employee over his or her highest consecutive three-year period. For defined contribution plans for 2008, employers may contribute up to the lesser amount of $46,000 ($51,000 if age 50 or older) or 100% of compensation, subject to an annual compensation limit of $230,000. For 2008, you may contribute up to $15,500 to a qualified 401(k) plan. If you are age 50 or older, you may contribute an additional $5,000, or a total of $20,500.
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Rate of Return: Rate of return is the percentage gain or loss on an investment expressed as a yearly rate. Rates of return for periods shorter than or longer than a year are annualized, or converted to a yearly rate. Rates of return for multiple-year periods can be stated as average or compounded returns. The most comprehensive way of measuring rate of return is total return. Total return includes income earned on distributions while you own the investment, as well as investment income earned on that income.
Rebalancing (reallocation): Rebalancing is the process of shifting assets from one category or another in order to maintain a targeted allocation. Rebalancing is also called reallocation. Financial advisers suggest that you rebalance periodically in order to fine-tune the percentage weightings of your portfolio. In some cases, rebalancing requires selling securities and buying new ones belonging to a different asset class in order to complete the process.
Recommended Allocation: Recommended allocation is a financial professional's suggestion on where to allocate your investments. A recommended allocation reflects an analysis of your investment profile. For example, if you are an aggressive investor, an adviser may recommend an allocation of 80% of your portfolio to stocks. If your portfolio had only 60% in stocks, you would move an additional 20% of portfolio value to stocks.
Refinancing: Refinancing is a means of replacing high-interest debt with a loan that has a lower interest rate. But it can also be done in order to switch from a fixed to variable rate, or vice versa, or to eliminate a balloon payment. A cash-out refinancing is one that involves you paying off your loan and borrowing an additional amount. The entire loan amount is secured by a mortgage lien on your home.
Regular IRA: A regular IRA is also called a traditional IRA. It is a tax-deferred retirement account. For 2008, you are allowed to make a tax-deferred contribution of $5,000 to a regular IRA. This account grows tax-deferred until you begin to take distributions, which you may do after you turn age 59-1/2. For persons who are age 50 or older, a special catch-up provision of the 2001 tax law allows you to contribute an additional $1,000, or a total of $6,000. You are required to begin taking distributions from a regular IRA every year after reaching age 70-1/2 according to a schedule that is based on your age and the corresponding distribution period specified in the Uniform RMD Table. (See Appendix C of IRS Pub. 590: Life Expectancy Tables.)
Repayment Plan: A systematic plan you use to repay debt. First, review personal budget and personal cash flow to see how much you can pay on a periodic basis. Next, pick a period in which you want to repay the debt. Finally, calculate a monthly payment. While repaying a debt, you want to avoid increasing your debts. That will only prolong the time that it takes to repay, and will discourage you. In other words, a repayment plan also requires spending discipline. For example, you may aim to repay a $1,000 debt in 12 months.
Required Beginning Date: Your required beginning date is the latest possible date that you must begin to take distributions from a regular IRA. If it is your IRA, this date is April 1 of the following year that you reach age 70-1/2.
Required Minimum Distribution (RMD): Required minimum distributions are the minimum amount you must take out in a year from a regular IRA. Required minimum distributions are called both RMDs and MRDs. You are required to begin receiving RMDs from a regular IRA in the year you reach age 70-1/2. Roth IRAs do not have required minimum distributions. Amounts for required minimum distributions are based on your age, IRA account balance and life expectancy. To calculate an RMD, divide your year-end IRA account balance (adjusted for certain contributions and distributions) by the applicable divisor in Table III: Distribution Period Table, found in Appendix C of IRS Pub. 590.
Revolving Credit: A form of open-ended credit, which means that a borrower is allowed to draw down on the credit line for the amount of the limit, repay at least some of the loan, and then draw down on the line again. In some cases, minimum payments or cleanup periods are used to periodically ensure that the borrower has the capacity to repay the line.
Revocable Living Trust: A revocable living trust is one that you can revoke or modify while you are alive. It offers more flexibility than an irrevocable trust.
Rewards Card: A credit card that rewards the cardholder with points, miles, or similar compensation for each dollar in new purchases. The most widely used category of rewards cards is frequent-flier cards. For example, if you were to spend $5,000 using a frequent-flier card, the airline that is affiliated with the card company would reward you with 5,000 miles. Other rewards cards include cash and merchandise rebate cards.
Risk Charges: Risk charges are synonymous with mortality and expense (M & E) fees. These are yearly fees that an annuity contract owner pays to the life-insurance company that sold the contract. Risk charges average about 1.25% of a contract's value. Risk charges are to pay for adjustments the insurer faces in the risk of its pool of insurees.
Risk Return Trade Off: A basic investing principle that says the higher the potential rate of return, the higher the investment risk. Academic and industry studies support this relationship. For example, stocks historically offer a higher rate of return than bonds. They also have a higher degree of investment risk. Investment risk is measured by the volatility of investment returns.
Rollover: A rollover is the process of converting a distribution you receive from a qualified employer-sponsored retirement plan to a retirement plan at a new employer or individual retirement account. Under the rollover terms, you must generally convert the distribution within 60 days or else you will be liable for income taxes and, possibly, an early-withdrawal penalty. If you own shares of qualified small business stock, you may be able to roll over some or all of a capital gain on its sale if the replacement stock you buy is also qualified small business stock. Other conditions apply. For more information on Section 1045 rollovers, see IRS Pub. 550.
Roth Conversion: A Roth conversion is the process of moving assets from a regular IRA to a Roth IRA. Because regular IRAs are funded with tax-deductible contributions, you must pay income taxes on the converted amount in the year that you convert. This is because Roth IRAs are funded with after-tax contributions. For example, if you convert $10,000 to a Roth IRA and are in the 25% income tax bracket, you would owe $2,500 in income taxes. If you own a Roth IRA for at least five years, the entire amount of the account is tax-free.
Roth IRA: A Roth IRA is a tax-advantaged retirement account that allows you to make an after-tax contribution of $5,000 for 2008. For persons who are age 50 or older, a special catch-up provision allows you to contribute an additional $1,000, or a total of $6,000. If you keep a Roth IRA for at least five years and are at least age 59-1/2 when you begin to withdraw from the account, the entire account may be distributed tax- and penalty-free. Your entire balance may also be distributed tax- and penalty-free if you have held the account for at least five years and are disabled, are taking out up to $10,000 to buy a first home, or payments are being made to a beneficiary of your estate after your death.
Roth Rollover: A Roth rollover is a process of converting the assets from a regular IRA to a Roth account. First, you receive a lump-sum distribution from your regular IRA. You have 60 days to roll over the account, or you will owe income taxes and will likely have to pay an early-withdrawal penalty.
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SARSEP: SARSEP plans are SEP plans that were opened before 1997. SARSEP stands for Salary Reduction Simplified Employee Pension. These plans have a salary-reduction feature not available in SEP plans. With a salary-reduction plan, the employees make pretax contributions to the retirement accounts. These contributions are called elective deferrals. The amount that can be contributed in elective deferrals to a SARSEP plan is $15,500 in 2008.
Savings Plan: A systematic plan you use to save for a specific financial goal. If you have more than one financial goal, you may wish to set up a savings plan for each goal. First, review personal budget and personal cash flow to see how much you can save on a periodic basis. Next, pick a period in which you want to save the desired amount. Finally, estimate a realistic rate of return. It's important that you save regularly and avoid paying income taxes on your earnings, if possible. One way to do this is to contribute first to tax-advantaged retirement accounts and college savings plans.
Section 1035 exchange: Named for the section of tax code that governs it, a Section 1035 exchange allows you to make a tax-free exchange of assets. Buying and selling annuities is one activity that generally qualifies as a Section 1035 exchange.
Secured Credit:Credit that requires collateral to guarantee repayment of debt. Mortgage, home equity and auto loans are forms of secured credit.
Secured Credit Card: A credit card that requires you to deposit an amount that equals the amount you are able to borrow. Secured credit cards are a form of secured credit. This means your cash deposit guarantees repayment of your credit card debt. Because of this obligation to give the lender collateral.
Secured Sockets Layer (SSL): Secured Sockets Layer (SSL) is an encryption technology for transmitting data across public networks such as the Internet. Your transactions on the Internet should be limited to those Web sites that use SSL technology. To determine if the site uses SSL, look for a uniform resource locator (URL) that begins with "https" or an icon of a padlock.
Section 529 plans: A Section 529 plan is a tax-advantaged account used to save for the college education of a child, grandchild or other dependent. Section 529 plans are run by state governments (and some private colleges) and include college savings plans and prepaid-tuition plans. Section 529 plans are named for the section of tax code that governs them. Investors contribute to an account that is managed by the investment board or treasury of the state in which the account is opened. Section 529 plans are offered in the form of prepaid tuition plans in 17 states and as college savings plans in 49 states. Tax laws for contributions and distributions vary from state to state. Both plan types allow for tax-deferred growth in the account. Funds taken from a Section 529 plan to pay for qualified higher education expenses are tax-exempt.
SEP IRA: SEP-IRA is an individual retirement account an employer sets up for each eligible employee that participates in a Simplified Employee Pension (SEP) plan. The employer makes SEP plan contributions to this account.
SEP Plan: A SEP plan is an employer-contribution retirement plan for self-employed persons or small businesses (25 or fewer employees). SEP stands for Simplified Employee Pension. Employers establish a SEP plan by opening individual accounts called SEP-IRAs for each eligible employee. For 2008, your employer may contribute up to $46,000 or 25% of your compensation to your SEP-IRA.
Service Years The Pension Benefit Guaranty Corp. defines a service year as a 12-month period in which the employee has worked at least 1,000 hours.
Simple Interest Rate: The simple interest rate is the interest that you earn on savings, stated as a yearly percentage. For example, $1,000 invested at 10% earns $100 in interest in one year. The opposite of simple interest is compounded interest. This is the interest you earn on interest that you have reinvested. For example, if you received payments of $25 every three months and reinvested it for the remaining terms of nine, six and three months, you would earn an extra $3.80. This is the amount of compounded interest. Your compounded interest rate, in this case, is 10.38%.
SIMPLE IRA: A SIMPLE plan is an employer-contribution retirement plan for self-employed persons or small businesses (100 or fewer employees). Employers establish a SIMPLE plan by either opening individual retirement accounts (SIMPLE-IRAs) or 401(k)-type accounts for each eligible employee. For 2008, you may contribute up to $10,500 to your SIMPLE-IRA. If you are age 50 or older, you may contribute an additional $2,500, or a total of $13,000. If the employer makes elective contributions, it is required to contribute 3% of salary, up to the salary limit of $230,000 for 2008. If it makes non-elective contributions, it is required to contribute 2% of salary, up to the limit. Non-elective contributions are required whether or not the employee makes a salary-reduction contribution.
SIMPLE Plan: A SIMPLE plan is an employer-contribution retirement plan for self-employed persons or small businesses (100 or fewer employees). SIMPLE is an acronym for Savings Incentive Match Plan for Employees. Employers establish a SIMPLE plan by either opening individual retirement accounts (SIMPLE-IRAs) or 401(k)-type accounts for each eligible employee. For 2008, you may contribute up to $10,500 to your SIMPLE-IRA. If you are age 50 or older, you may contribute an additional $2,500, or a total of $13,000.
Skilled Care: A level of care administered by a licensed provider such as a registered nurse or professional therapist, and that is often provided in a rehabilitative setting.
Social Security: Social Security is the federal retirement income security program in the U.S. The program is financed through Social Security taxes that you pay during your working years. If eligible to receive Social Security, you may start receiving benefits when you reach age 62. The minimum age for receiving full benefits is gradually increasing to 67 from 65.
Social Security Taxes: Social Security taxes are paid to Old Age Survivors and Disability Insurance (OASDI) and Medicare. For 2008, employee and employer each pay 7.65% of the first $102,000 of the employee's salary as Social Security taxes. For any additional income, employee and employer each pay 1.45% to Medicare. Self-employed persons pay 15.3% of their first $102,000 in salary to Social Security taxes in 2008. For higher incomes, they pay 2.9% to Medicare.
Soft Inquiries: Requests you make to obtain a copy of your credit report for periodic review, or by marketing firms to gather a list of potential card applicants. Soft inquiries are not tallied on your credit report.
Spread: Spread is the arithmetic difference between two interest rates, usually stated in basis points. One percentage point consists of 100 basis points. For example, a spread on a card that charges 14% and one that charges 12.5% is 150 basis points.
Stocks: A stock is a financial asset that represents a unit of ownership in the company that issues the stock. Individual units of stock are called shares. Stocks are also called equities because they represent an equity interest in the company. If you own stock in a company, you are called a shareholder. Shareholders are entitled to share in the distribution of profits that the company makes. If a company goes bankrupt, or its stock price falls to zero, you have no claim or recourse to recover your investment. Together with bonds and cash, stocks represent a major asset class for making asset allocation decisions.
Subaccount: A subaccount is an investment account used by variable-annuities owners. It is modeled after a mutual fund that shares the same investment objective and fund manager. Fees of a subaccount differ from fees of the underlying mutual fund. As a result, its investment performance also differs slightly. An annuity contract often consists of several subaccounts.
Sunset Provision: The Economic Growth and Tax Relief Reconciliation Act of 2001 has a "sunset" provision that calls for the various statutes of the law to expire in 2011. Some statutes of the tax law expire sooner than 2011.
Supplemental Security Income (SSI): Supplemental Security Income (SSI) is income that you receive from the federal government that is in addition to your own Social Security benefits. SSI supplements your income to partially offset the loss of Social Security income that occurs when your spouse dies and no longer receives benefits.
Surrender Charge: A surrender charge is a fee that you pay to cancel a life insurance policy or annuity contract. A surrender charge is also called a deferred sales charge or back-end load. Annuity contracts have a surrender charge as high as 9% of the purchase payment in the early years of the contract. The charge is slowly phased out, often at a rate of 1 percentage point every year. High surrender charges hurt investment performance of variable-annuity contracts, which invest in mutual fund-like accounts called subaccounts.
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T Account A t-account illustrates the composition of the balance sheet of a company or individual. A t-account shows the assets on the left side, and liabilities and net worth on the right side. Assets minus liabilities equal net worth. As a result, the total on the left side equals the total on the right side of the t-account. For example, if you have $100,000 in assets and $70,000 in liabilities, you have $30,000 in net worth. (For companies, net worth is called shareholders equity.) Each side of the t-account has $100,000.
Tax Advantaged Account A tax-advantaged account is an investment account with tax-deferred or tax-exempt features. The Internal Revenue Service authorizes the use of tax-advantaged accounts. These accounts are used to save for retirement or college and other educational expenses. Tax-advantaged accounts are tax-exempt until you take money out of the account. In some cases, distributions are tax-exempt provided the account holder meet certain conditions or the money is spent a certain way. In other cases, the entire amount of the distribution is taxable.
Tax Credit: A tax credit is a dollar-for-dollar reduction in taxes that you owe. For example, if you paid $1,000 in taxes and receive a $500 tax credit, you will be refunded $500. If you owe $1,000 and are eligible for a $500 tax credit, the amount you owe is reduced to $500.
Tax Deductible: A tax-deductible expense or contribution reduces your taxable income. To calculate the worth of a tax deduction, multiply the deduction by your income tax rate. For example, if you deduct $10,000 in mortgage interest expense and are in the 25% income-tax bracket, the tax deduction is worth $2,500. If you deduct $1,000 in contributions to a charity, the tax deduction is worth $250.
Tax Deferred Account: A tax-deferred account allows you to postpone, or defer, paying taxes on earnings from the account. These are accounts that allow you to save for your retirement. A traditional IRA, 401(k) plan, or variable annuity is an example of a tax-deferred account. A major advantage is that your earnings grow compounded, tax-free, until you take money out. For example, if you invested $2,000 a year in a tax-deferred account at 8%, it would grow to $31,291 at the end of 10 years. A taxable account with the same contributions will only grow to $27,568 over the same time. When you begin to take money out of the account, you pay taxes only on that amount. Another benefit of a tax-deferred account is that you may also be in a lower tax bracket when you begin to take money out. This is because retirees, on average, earn less than they do in their working years.
Tax Deferred Contribution: A tax-deferred contribution is not taxed at the time the contribution is made to a 401(k) plan or other tax-advantaged account. As a result, the contribution grows to a larger amount than if it were taxed in the year of the contribution. A tax-deferred contribution is taxable in the year that you withdraw it from the account.
Tax Deferred Investment: A tax-deferred investment is an investment that allows you to postpone, or defer, paying income taxes until you begin to take money out of the account. IRAs, 401(k) plans, and variable annuities are examples of tax-deferred investments. The advantage of a tax-deferred investment is that it compounds to a larger amount than if you paid taxes each year.
Taxable Account: A taxable account is an account that does not receive the tax breaks that either a tax-exempt account or tax-deferred account are eligible to receive. (Both of these accounts are called tax-advantaged accounts. Tax-advantaged accounts are authorized by the IRS as investment vehicles to save for your retirement or the retirements of investors.)
Taxable Income: The amount of income on which you owe income taxes, calculated by subtracting any deductions and exemptions from your adjustable gross income. For your federal tax return, your taxable income is on Line 43 of IRS Form 1040 for 2007.
Teaser Rate: An interest rate on a consumer loan or credit card offer that is below the level of normal interest rates. Teaser rates are offered for a temporary period and are used as a marketing tactic by creditors to generate new business. They are often called introductory, or intro, rates. The length of time, or intro period, that a teaser rate is available depends on the product. For credit cards, it may be three to six billing periods or months. For auto loans, the teaser rate may apply for the entire loan term, depending on levels of dealer inventories.
Term Life Insurance: A term life insurance policy provides a death benefit for a specific term, generally measured in years. Unlike permanent life, there is no buildup in cash value. When the coverage term expires, the policyholder buys a new term that matches his insurance needs. Since the policyholder is older, they will pay a larger premium to reflect their shorter life expectancy.
Trade-in Value: A dealer assigns a trade-in value to an auto, boat or other vehicle that a buyer wishes to exchange for a replacement vehicle. Trade-in value, also called trade-in allowance, is subtracted from the purchase price of the vehicle. Trade-in value is often based on the published book value of the vehicle. As a general rule, a vehicle with less wear and tear has greater trade-in value.
Transfer Balances: Credit card balances that you move to a new credit card company to take advantage of a lower interest rate.
Treasury bills (T-bills): U.S. Treasury bills are short-term debt obligations of the U.S. Treasury. T-bills are usually issued to mature in three or six months. Prices for T-bills are stated as a discount to the par value. For example, a T-bill with a price of 99.65 is selling for 99.65% of its par value. T-bills are auctioned weekly and used to pay operations of the federal government. T-bills are considered to be among the safest and most liquid investments.
Trust Account: A custodial account involving an administrator, or trustee, that defines how your assets are to be distributed to your beneficiaries. Trust agreements are used for inter vivos trusts, which can be either revocable or irrevocable.
Trustee: A custodian of a trust account responsible for distributing the trust's assets in accordance with the trust agreement.
Trustee to Trustee Transfer: A trustee-to-trustee transfer is a process of converting assets from a qualified employer-sponsored retirement plan to an IRA, or from a regular IRA to a Roth account. Trustees of the accounts handle either transaction. Neither transaction triggers a taxable distribution, even if the rollover is not completed in 60 days.
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Underwriting: Underwriting means different things to different financial-services industries. For mortgage lenders, it is the process of evaluating a loan prospect to see if they have the financial capacity to repay the loan. For investment bankers, it is the process of arranging a sale of stocks or bonds to investors. For insurance companies, it is the process of calculating a premium for a specific pool of insurees with certain risk characteristics such as age or health.
Unified Tax Credit: A unified credit is a tax credit reserve that you use to eliminate or reduce estate taxes. A tax credit is a dollar-for-dollar reduction in the amount of taxes you owe. While you are living, you can deduct a unified credit of $345,800 from the amount of gift taxes that you owe. When you die, you can deduct a unified credit from the amount of estate taxes owed. The estate tax unified credit for 2008 is $780,800. This unified credit amount corresponds to the 2008 applicable exclusion limit of $2 million.
Universal Life Insurance: A type of permanent insurance that allows you to change your premiums and death benefit based on your needs and income. Your buildup in cash value is generally guaranteed a minimum rate of return based on money market yields but you cannot select your investments as you can with a variable life insurance policy.
Unsecured Credit:Credit that does not require collateral to guarantee repayment. Credit cards and personal loans are forms of unsecured credit. As a result of the higher risks associated with unsecured credit, lenders charge a higher interest rate than for secured credit. Secured credit requires collateral to guarantee repayment. Mortgage, home equity and auto loans are forms of secured credit.
URL: An acronym that stands for Uniform Resource Locator. This is the Web address that you enter, or is displayed, on the Web browser (e.g., http://www.WebSite.com).
Usury Laws: Laws passed by state governments to protect consumers from predatory lenders charging excessively high interest rates. Usury laws set a maximum, or ceiling, interest rate that lenders are allowed to charge. About half of the states have a usury law. Arkansas is consistently ranked as having the most consumer-friendly usury law, limiting the ceiling rate to 5 percentage points over the discount rate. The discount rate, set by the Federal Reserve, is the interest rate it charges banks to borrow. As of January 2008, the discount rate was 4.75 percent.
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Variable Annuity: A variable annuity is an annuity that pays a variable amount. This is because the payment is determined by the investment performance of mutual fund-like subaccounts that underlay the annuity. A variable annuity is taxed the way an IRA is: contributions are tax-deferred until you take money out of the account. If you take money out before turning age 59-1/2, you owe a 10% early-withdrawal penalty. Unlike IRAs, however, variable annuities do not have a yearly contribution limit.
Variable Life Insurance: A form of permanent insurance that allows the policyholder to invest a portion of the cash value of the policy in a portfolio of stock, bond and money market investments. Premiums are fixed and a share of them is allocated to the investment portfolio. The policyholder bears the risk from these investments in the form of a cash value and death benefit that fluctuates with the performance of the investment portfolio.
Variable Universal Life Insurance: A type of permanent insurance that combines the features of variable and universal life insurance. Specifically, the policy allows the policyholder to change his premiums based on income and needs (which is characteristic of a universal life policy) with the flexibility of investing a share of the premium in a portfolio of stock, bond and money market investments (which is characteristic of a variable life policy).
Vesting: Process by which an employee earns legal right of ownership to benefits, most commonly deferred compensation such as a pension, stock options or stock ownership plan.
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Weighted Average Interest Rate: From the perspective of a borrower, the weighted-average interest rate is the effective interest rate paid on debts after adjusting for the proportion of each debt. For example, if you pay 10% on $1,000 of debt and 15% on $4,000 of debt, your weighted-average rate is 14.0%. From the perspective of an investor, the weighted-average interest rate is the effective interest rate earned on investments after adjusting for the proportion of each investment. For example, if you earn 8% on $1,000 of investments and 12% on $4,000 of investments, your weighted-average rate is 11.2%.
Whole Life Insurance: A type of permanent insurance that calculates your premiums based on the remainder of your expected life span. Both premiums and the death benefit are fixed. Your death benefit is reduced if you have any outstanding loans that are collateralized with the cash value of a whole life policy.
Will: A will is a legally enforceable statement of how you wish to distribute your wealth after your death.
Withholding: Withholding is the amount of taxes and other payments that are regularly deducted from your pay by your employer. The withholding rate is the percentage of income that is withheld. Your payroll and income tax withholding is based on how you complete IRS Form W-4.
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