Pros and Cons of Options to Fund Your Retirement

There are pros and cons to everything, especially when it comes to financial planning. Making plans for your retirement fund should always involve a risk assessment as well as deciding what’s going to be the best plan for you. We’ve highlighted six options to fund your retirement and weighed the pros and cons of each.

401(k)

A 401(k) is a retirement fund that’s sponsored by an employer. Employees can contribute to this plan at their discretion, while employers can offer matching contributions.

Pros

If your employer matches your 401(k) contributions, you’re essentially getting free money added to your retirement fund. For example, if you’re contributing 3% of your income to your 401(k), then your employer is matching contributes a 100% match, you’re getting 6% of your annual income into your retirement fund each year. Additionally, a 401(k) allows you contribute a larger dollar amount each year than other plans with up to $19,500 or up to $26,000 if you’re over 50 years old.

Cons

If you’re retiring early, there are penalties that can be up to 10% of your early withdrawal. This can leave you feeling handcuffed by not wanting to lose a significant chunk of your nest egg to penalties.

Traditional IRA

An IRA is an individual retirement account. This account allows you to make individual pre-tax payments toward your retirement fund in addition to what you’re already contributing to your 401(k).

Pros

A major pro to contributing to a traditional IRA is that anyone can contribute to the account. Whether you’re looking to contribute entirely from your own income, have a working spouse who is planning to contribute, or you want to invest a lump sum of money, it doesn’t matter where your contributions come from. Your traditional IRA contributions are tax-deductible and your funds are protected if you file for bankruptcy.

Cons

As of 2021, your traditional IRA contributions are limited to $6,000 a year, or $7,000 if you’re 50 years old or older. Furthermore, your contributions are tax-deductible, but your distributions can be taxed.

SEP IRA

The “SEP” in SEP IRA stands for “Simplified Employee Pension.” A SEP IRA is similar to a traditional IRA, except a SEP IRA is for business owners and contributions are tax-deductible.

Pros

Like other retirement plans, there are limits to how much you can contribute annually. However, the limit is much higher than previously mentioned plans. A SEP IRA allows for up to 25% of your annual compensation with a maximum contribution of $58,000. Like a 401(k), your SEP IRA contributions grow with no immediate tax implications but are paid on distribution.

Cons

Unlike a 401(k), you cannot borrow against your SEP IRA. Most other cons that come with a SEP IRA are employer-based as soon as you contribute to your account you’re fully vested.

Roth IRA

A Roth IRA is another investment option but it’s unique because it allows retirees to take tax-free distributions.

Pros

After you’ve contributed to your Roth IRA, your savings will grow tax-free for as long as you like. While a traditional IRA requires that you start taking distributions at age 72, this is not the case with a Roth IRA. You can keep the money in your account until the day you die if you so choose.

Cons

Your contributions to your Roth IRA are post-tax, which means that the amount takes a bigger hit against your income. These contributions have the same annual cap as a traditional IRA. You also can’t take distributions from your Roth IRA until you’re 70 years old.

Reverse Mortgage

While a traditional mortgage is a loan that’s meant to buy a house, a reverse mortgage is a loan that is taken out against the equity in your home before or during retirement.

Pros

A reverse mortgage is a great way to get a significant sum of money quickly. If you own at least 50% equity in your home and you’re at least 62 years old, you can qualify for a reverse mortgage. An added benefit is that your loan won’t need to be paid back until after you or your heirs sell the home. To get real-time interest rates and get fast advice, check out this reverse mortgage calculator: https://reverse.mortgage/calculator.

Cons

The value of your home can fluctuate. If you take out a reverse mortgage at 50% equity and the housing market crashes, you could end up paying back considerably more than the loan amount you took after interest.

Social Security

Social Security is a government fund that’s designated to replace a percentage of your pre-retirement working wage. Your monthly Social Security income is based on your lifetime earnings.

Pros

You’ve contributed to Social Security the entirety of your working life, get some of that money back with a monthly distribution. This is a solid stream of money that you can count on to supplement your monthly distributions. 

Cons

Social Security payments aren’t that much. They’re designated to provide 42% of your pre-retirement expenses. If you don’t have another savings plan in place, Social Security won’t be nearly enough to cover everything you need during retirement. 

Conclusion

No matter how you decide to plan for retirement, there are going to be pros and cons to all. You can counteract some of the cons by supplementing with multiple savings plans. Speak with a financial advisor to decide what is best for you and your retirement plan.