401(k) vs. Life Insurance: Which One Is Better for Retirement?

Utilizing the right savings plan can help you prepare your finances for the future. Although certain types of life insurance and 401(k) have a slight overlap, they have very different purposes. Life insurance is the better choice for estate planning, while a 401(k) is ideal for retirement.

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Last Updated: 11/17/2022
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Both life insurance and a 401(k) can serve as investment tools. Determining which is the better choice for you will depend on your long-term goals. Because they serve different purposes, you may be interested in both.

A 401(k) plan is better for retirement planning. Because it’s designed for retirement, the returns are typically better and will benefit you once you end your working career. Life insurance, on the other hand, is better for estate planning because it’s focused on the death benefits that your loved ones will receive if you pass away.

Although some types of life insurance have a savings portion, that is only a bonus, and investment returns aren’t very good. In most cases, including variable life insurance, returns aren’t even guaranteed.

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What Is the Difference Between 401(k) & Life Insurance?

Life insurance and 401(k) plans can benefit individuals concerned about their future financial situation; they have different purposes, but you could choose either as part of your retirement plan.

401(k) plans are employer-managed savings plans for retirement. A certain amount from a participating employee’s paycheck is allotted to the account.

Meanwhile, life insurance offers financial protection for the policyholder’s beneficiaries. You pay a premium to your insurance provider to maintain coverage. It’s mainly focused on the death benefit, but some types have an investment component that may help with retirement savings.

A 401(k) retirement fund is typically company-sponsored and is part of an employee benefits package — signing up means using a portion of your salary as a contribution to your retirement account.

Life insurance, on the other hand, mainly offers protection to beneficiaries in the event of your death to cover large expenses, such as a mortgage. It may not be an ideal retirement plan. Although the cash value from permanent life insurance can serve as a supplementary tool to retirement savings, it shouldn’t replace a 401(k) or another retirement plan.

401(k) vs. Life Insurance

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401(k)
  • It’s designed for retirement.
  • It’s an employer-managed retirement savings plan.
  • A portion of a participating employee’s wages automatically goes to their 401(k).
  • The plan owner decides how much their annual contribution will be.
  • Companies may offer to match contributions up to a certain limit, increasing the total contribution.
  • Making withdrawals before the age of 59 ½ lead to a 10% additional tax.
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Life Insurance
  • It provides financial protection to beneficiaries in the event of the policyholder’s death.
  • Coverage depends on the person.
  • It can have an investment or cash-value component, which provides an opportunity to earn money.
  • Premiums are calculated by the insurance provider based on individualized factors.
  • Returns are often not as good as 401(k) and may not be guaranteed.
  • Cash value is easily accessible via withdrawal or loan at any time.

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DO YOU STILL NEED LIFE INSURANCE IF YOU HAVE A 401(K)?

Both life insurance and 401(k) offer advantages. That’s why many find it difficult to choose one over the other. But choosing life insurance vs. 401(k) isn’t always necessary.

Buying life insurance alongside having a 401(k) can help you maximize the benefits and create a more solid wealth strategy. A permanent life insurance policy can give you access to cash value that you can use for various purposes. That can be a great addition to your retirement nest egg that you accumulate in your 401(k).

Comparison of Contributions for 401(k) vs. Life Insurance

Generally, permanent life insurance has two components: death benefit and cash value. Having these leads to a higher insurance rate.

The death benefit is the amount beneficiaries receive when the policyholder dies. Cash value is the savings component of a permanent life insurance policy, such as whole life and universal life. It’s invested and may earn interest. It can be accessed after a certain amount of time.

Read below to see how life insurance and 401(k) rates compare.

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    401(k)

    Minimum Contribution: There’s no minimum contribution for a 401(k) plan. In some cases, a company may offer a matching program wherein they match the employee’s contribution up to a certain percentage. If your company has this, you can use this as the basis for your minimum contribution.

    Maximum Contribution: In 2023, a participating employee can contribute up to $22,500 per year to their 401(k) account. Those aged 50 or older can allot up to $30,000 annually.

    If your company has a matching program, the maximum employee-employer contribution is $61,000 for most and $67,500 for those 50 years old or older.

    Contribution Frequency: A portion of a participating employee’s salary is automatically contributed to their 401(k). The agreed-upon amount is deducted from the employee’s gross wages every pay period.

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    Life Insurance

    Minimum Contribution: A percentage of life insurance premium payments goes toward the policy’s cash value. That means the amount of contribution may vary by policy type. It may also vary by the insurance provider.

    Maximum Contribution: The maximum contribution for the cash value component may vary by company. The percentage may also change throughout the years. Make sure you clarify with your insurer and read the fine print to avoid issues.

    Contribution Frequency: Depending on your premium payment plan, your contribution can be made monthly, semi-annually or annually. That’s because a portion of the insurance premium goes toward the policy’s cash value component.

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You can’t purchase life insurance in a 401(k) plan unless your plan explicitly allows it. Make sure you check the plan description to see if it is possible. If it’s allowed, you can purchase a cheaper policy using pre-tax money. It’s also important to clarify with your employer whether you’re allowed to purchase an individual life insurance policy or if you can only buy group life insurance through them.

Benefits of 401(k) vs. Life Insurance

When planning for retirement, it’s important to consider the different financial instruments you can use. Knowing the benefits of each can help you weigh your options well. For instance, 401(k) may have better savings potential, but life insurance offers a death benefit.

The table below shows a comparison between 401(k) and life insurance in terms of benefits.

Comparing 401(k) and Life Insurance
  • Benefit
    401(k)
    Life Insurance
  • Savings
    Potential

    A 401(k) plan provides better
    returns. That’s because it is
    designed for retirement savings.

    A certain portion of the insurance
    premium is put into the cash value
    component of the policy.

    Depending on the type of life
    insurance plan, there may be a
    savings potential. Term life doesn’t
    offer this option. Permanent life
    insurance, such as whole and
    universal, does.

  • Death Benefit

    401(k) is a retirement account and
    doesn’t offer death benefits. But,
    the balance of your 401(k) is left to
    your chosen beneficiary.

    One of the main components of life
    insurance is the death benefit. That
    amount is paid out to chosen
    beneficiaries when the policyholder
    passes away.

  • Investment

    401(k) plans offer various
    investment options. Typically,
    companies already have a
    portfolio, and participating
    employees can choose where to
    invest.

    Universal life insurance allows the
    policyholder to choose how much of
    their premium payments will go toward
    the cash value, which may accumulate
    interest. Some insurance companies
    may also offer choices for where the
    cash value is invested.

    Indexed universal life insurance is also
    a policy that offers investment
    opportunities. It allows you to get
    faster cash value growth.

  • Tax Benefits

    Your 401(k) contributions are
    made pre-tax. You can deduct
    them in the year and potentially
    reduce your total taxable income.

    The earnings of a 401(k) account
    are also tax-deferred.

    Insurance death benefits are often
    tax-free.

    The cash value accrues on a
    tax-deferred basis.

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Having life insurance provides your loved ones financial protection after you pass away. The death benefit component is paid out to them and can be used in various ways. However, life insurance isn’t an upgrade to 401(k). If your goal is to save for retirement, it’s best to consider a 401(k) plan.

Which One Should You Get: 401(k) or Life Insurance?

Choosing life insurance vs. 401(k) requires you to consider your needs, circumstances and goals. Generally, what your priorities are in terms of retirement planning and wealth strategy will determine which is the better choice for you.

When to Choose 401(k) vs. Life Insurance
  • Goal
    Best Option
  • Retirement Fund

    401(k)
    401(k) was created to help employees plan for retirement. In comparison to life insurance, 401(k) has a stronger savings potential. The investment earnings may compound over time. Additionally, some companies match employee contributions, helping you save more for retirement.

  • College Fund

    Life Insurance
    One component of permanent life insurance is the cash value. After a certain amount of time, the policyholder can access this amount. You can borrow against it or withdraw a portion to cover various needs, such as to pay for your child’s college education.

    401(k) doesn’t offer this option. You can’t withdraw funds before the age of 59.5 without a tax penalty.

  • Estate Planning

    Life Insurance
    Life insurance can be used for estate planning. The death benefit component is given to your chosen beneficiaries. It can be used to balance asset value and equalize inheritance distribution.

  • Funeral Expenses

    Life Insurance
    Funeral and burial costs can be expensive. The death benefit of your life insurance can help your loved ones pay for these expenses.

    Although it’s possible to have leftover funds from a 401(k) that you can pass on to your loved ones, it’s not a guaranteed amount.

Life insurance and 401(k) are used differently. If your main concern is retirement planning, a 401(k) is the better option for you. But before participating in one, make sure you know how it works and the different types. Additionally, check the plan details with your employer’s human resources department.

If you think that buying life insurance is appropriate for your situation and goals, consider the different types of life insurance available. Comparing policies and rates from different insurance providers can help you find the best life insurance based on your needs.

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Frequently Asked Questions

Understanding the different products available to you can help you make an informed decision. MoneyGeek answered some common questions to help you get a better idea of life insurance vs. 401(k).

About the Author


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Mark Fitzpatrick is a senior content manager with MoneyGeek specializing in insurance. Mark has years of experience analyzing the insurance market and creating original research and content. He graduated from Boston College with a Bachelor of Arts and Johns Hopkins University with a Master of Arts.