Key Terms

This is part of Start Now — a complete guide to building your own tax-free pension, published free, one piece at a time. New here? Start Here →You'll usually find a glossary like this at the very back of a book. I've put it up front, on purpose. Start Now is being published a little unconventionally, one short piece at a time, each also read aloud as a podcast, so it helps to meet the key terms used early. There are more than fifty terms here, drawn from investing, finance, tax, and accounting, each with a plain-language definition. You don't need to memorize them, and you certainly don't need to read them straight through. Skim them now to get the lay of the land, and come back whenever a word trips you up. Even if all of this is brand new to you, with these at hand you'll be able to follow every step of the reasoning ahead. The terms are listed alphabetically:1099 — The tax form an independent contractor receives. A 1099 worker is self-employed for tax and retirement purposes and uses accounts like the solo 401(k) rather than an employer plan.401(k) — An employer-sponsored defined-contribution retirement account. The employee contributes from their paycheck (often with an employer match), chooses investments, and bears the investment risk. Similar in spirit to an IRA but offered through a workplace.403(b) — A retirement account much like a 401(k), but offered by nonprofits, public schools, and government employers. Contributions come from your paycheck and grow tax-advantaged.529 plan — A tax-advantaged account for education. After-tax money grows and is withdrawn tax-free when spent on qualified education such as tuition; spent on anything else, the earnings are taxed and penalized. Leftover funds can now be rolled into the beneficiary’s Roth IRA, within limits.530A account (Trump account) — A federal account for children created by the 2025 tax law (also called a Trump account). The government seeds eligible children born 2025–2028 with $1,000; family may add up to $5,000 a year, invested in a low-cost U.S. stock index fund. It becomes a Traditional IRA at adulthood.Annual gift tax exclusion — The amount you can give any one person in a year without using your lifetime gift and estate tax exemption or filing a gift tax return, $19,000 per recipient in 2026 ($38,000 for a married couple who split the gift).Annuity — A contract, usually with an insurance company, in which you hand over a lump sum in exchange for a guaranteed stream of income, often for life.Asset allocation — How a portfolio is divided among kinds of investments: stocks, bonds, cash, and anything else. The single biggest driver of how a portfolio behaves, more than any individual pick inside it.Backdoor Roth — A legal technique that lets high earners who exceed the Roth income limits still fund a Roth: they contribute to a Traditional IRA and then convert it to a Roth.CAPE (cyclically adjusted P/E) — The cyclically adjusted price-to-earnings ratio, popularized by Robert Shiller: stock prices measured against average inflation-adjusted earnings over the prior ten years. A high CAPE has historically signaled lower returns over the following decade.Capital gain — The profit when you sell an investment for more than you paid. A long-term capital gain (asset held over a year) is taxed at lower rates than ordinary income at the federal level.Catch-up contribution — An extra amount that savers aged 50 and older may contribute above the standard annual limit.Compounding — Earning returns on your past returns, not just on your original contribution. Over decades the effect becomes exponential rather than linear, the central idea of this book.Custodial Roth IRA — A Roth IRA opened and managed by a parent or guardian for a minor who has earned income; control transfers to the child at the age of majority.Defined-benefit (DB) pension — A traditional pension that pays a guaranteed income for life in retirement, with the employer bearing the investment risk. Now rare in the U.S. private sector.Defined-contribution (DC) plan — A retirement account (such as a 401(k) or IRA) funded by contributions, where the final balance depends on investment performance and the individual bears the risk. There is no guaranteed payout.Dividend — A cash payment a company makes to shareholders out of profits. In a taxable account, dividends are taxed in the year received; inside an IRA they are not.Dollar-cost averaging — Investing a fixed amount at regular intervals regardless of price, so you automatically buy more shares when the market is low and fewer when it is high, a natural byproduct of steady, scheduled saving rather than a strategy you have to time.Diversification — Owning many investments instead of a few, so no single failure can sink you. An index fund is diversification taken to its logical end: own everything, and the winners you could never have picked in advance are always in the net.Earned income (compensation), Money from work, wages, salary, or self-employment income, as opposed to gifts, allowances, or investment income. Only earned income qualifies a person to contribute to a Roth IRA.Exchange-traded fund (ETF) — An index fund that trades like a stock, with rock-bottom fees and no minimum investment. The most convenient way to own a broad-market index fund.Financial capital — The money you have saved and invested: the balances in your accounts, working and compounding on your behalf. The second of the two assets a financial life converts between; see Human capital.Index fund — A fund that holds every stock in a market index (such as the S&P 500), in proportion, rather than trying to pick winners. It captures the whole market’s return at very low cost.Glide path — The planned, gradual drawdown of a portfolio through retirement, paced so the money outlasts the person.Inflation — The gradual rise in prices over time, which erodes the purchasing power of money. This book uses 2% per year to express future dollars in today’s purchasing power.IRA (Individual Retirement Account) — A tax-advantaged account an individual opens to save for retirement, independent of an employer. Comes in Traditional and Roth varieties.Life-cycle finance — The branch of economics that views a financial life as one long arc: borrow to build earning power when young, convert earnings into savings through the working years, then draw the savings down in retirement.Lifestyle creep — The tendency for spending to rise automatically with income, so raises disappear into a larger lifestyle instead of larger savings.Modified adjusted gross income (MAGI) — Your adjusted gross income with certain deductions added back. The IRS uses it to decide who can contribute directly to a Roth IRA, and to set other income thresholds.Net investment income tax (NIIT) — An extra 3.8% federal tax on investment income (such as capital gains and dividends) for higher earners, generally above about $200,000 of income for a single filer.Nominal vs. real return — A nominal return is the raw percentage gain; a real return subtracts inflation to show the gain in true purchasing power. A 10% nominal return is roughly a 7% real return after ~3% inflation.Ordinary income, Income taxed at the regular rate schedule, wages, interest, and Traditional IRA withdrawals. These rates are higher than long-term capital-gains rates.Present value (“today’s dollars”) — What a future sum is worth in today’s purchasing power, found by discounting it back at an assumed inflation rate. It answers “what would that future amount feel like if I had it now?”Pro-rata rule — A tax rule that treats all of your Traditional, SEP, and SIMPLE IRA balances as one pool when you convert money to a Roth. It means a backdoor Roth is only fully tax-free if you hold no other pre-tax IRA money, since each converted dollar is taxed in proportion to the pre-tax share of the total.Purchasing power — What a given amount of money can actually buy. Inflation erodes it over time, which is why this book often states future amounts in today’s dollars.Qualified dividend — A dividend that meets IRS holding-period rules and is therefore taxed at the lower long-term capital-gains rate rather than as ordinary income.Replacement rate — The share of your pre-retirement income that a source (such as Social Security or a pension) provides in retirement. Planners often target a total of 70–85%.Required minimum distribution (RMD) — The amount the IRS forces you to withdraw each year from a Traditional IRA starting at age 73 (rising to 75 for those born in 1960 or later), whether you need it or not. Roth IRAs have no RMDs during the owner’s lifetime.Return — What your money earns in a year, stated as a percentage of what you put in. Put in $100, finish the year with $108, and the return was 8%. It includes both price growth and any dividends the investment paid.Roth 401(k) — The Roth version of a 401(k), offered through many employers. You contribute after-tax dollars, and qualified withdrawals, including all growth, are entirely tax-free, at the much higher 401(k) limit.Roth IRA — An IRA funded with after-tax dollars; it grows tax-free and qualified withdrawals in retirement, including all growth, are entirely tax-free.Rule of 72 — A shortcut: divide 72 by the annual return to estimate how many years it takes money to double. At 10%, roughly every 7.2 years.SEP-IRA — A Simplified Employee Pension IRA: a straightforward retirement account for the self-employed and small businesses. The owner contributes a percentage of income, with far higher limits than a standard IRA.Shallow risk vs. deep risk — Shallow risk is a price decline that can reverse: violent in the short run, but only a paper loss unless you sell. Deep risk is a permanent loss of capital with no path back. The plan in this book accepts shallow risk and is built to avoid deep risk.Solo 401(k) — A 401(k) for a self-employed person with no employees. It lets you contribute as both employee and employer, reaching much higher limits than an IRA, the go-to account for independent workers who want to save aggressively.Spousal IRA — A rule that lets a working spouse fund an IRA for a non-working or low-earning spouse, so a married couple filing jointly can contribute to two IRAs on a single income.Tax-deferred (Growth that is not taxed year to year, but will be taxed later on withdrawal) the Traditional IRA model. (A Roth, by contrast, is tax-free, not merely tax-deferred.)Taxable account — An ordinary, non-retirement brokerage account. You invest after-tax money; dividends are taxed each year and gains are taxed when you sell. No contribution limits or withdrawal rules, but no tax shelter either.The 4% rule — A rule of thumb that withdrawing about 4% of a portfolio in the first year of retirement (then adjusting for inflation) historically lasted a 30-year retirement. See Section 1.5.Traditional IRA — An IRA funded with pre-tax dollars (a deduction today); it grows untaxed, but every withdrawal in retirement is taxed as ordinary income.W-2 employee — A traditional employee on a company’s payroll, with taxes withheld and reported on a W-2 form. W-2 employees can join their employer’s 401(k).Withdrawal rate — The percentage of a retirement portfolio taken out as income in a given year. A lower rate is safer; a higher rate risks depleting the portfolio.Yield on cost — The annual income an investment produces measured against what you originally paid for it, rather than its current value. A 4% withdrawal from a large balance can be a very high yield on the small sum first contributed.✦Coming next: 1 · The Magic of CompoundingA NOTE FROM THE AUTHORStart Now is free to read and free to share. If it helped you, the kindest thing you can do is subscribe and pass it to one person who needs it. 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