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

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. The returns are typically better because it’s designed for retirement and will benefit you once you end your career. On the other hand, life insurance is better for estate planning because it focuses 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.

• Difference Between 401(k) and Life Insurance
• Which One Should You Get: 401(k) or Life Insurance?
• Other Options for Retirement Planning
• Frequently Asked Questions

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.

On the other hand, life insurance mainly offers protection to beneficiaries in the event of their 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 be a supplementary tool to retirement savings, it shouldn’t replace a 401(k) or another retirement plan.

A life insurance retirement plan (LIRP) is a strategy that utilizes the cash value component of a permanent life insurance policy to provide retirement income. The policyholder contributes premiums that exceed the cost of insurance, allowing the excess to accumulate in a cash value account, which grows tax-deferred.

Policyholders can then take tax-free loans against the cash value of their policy during retirement, providing a stream of income. Although the death benefit decreases by the loan amount, this can be a useful tool for those looking for an additional retirement vehicle, especially if you have already maxed out other tax-advantaged accounts like 401(k)s or IRAs. LIRPs offer flexibility and tax benefits, but require careful planning to ensure that the premiums are affordable and the policy remains in force.

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.

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 compares 401(k) and life insurance in terms of benefits.

While both 401(k) plans and life insurance policies help achieve a robust financial strategy, each carries inherent risks and drawbacks. Make sure you balance the advantages with potential downsides to make an informed decision that aligns with your financial objectives.

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.

Life insurance and 401(k) are used differently. If your primary goal is to build a nest egg for retirement, a 401(k) often stands out as the superior option due to its tax advantages, potential employer matching contributions and the power of compound growth over time. 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.

On the other hand, life insurance shines in estate planning, offering a tax-free death benefit to your heirs, which can cover specific financial needs such as funeral expenses or establishing a college fund for children or grandchildren. Life insurance can ensure your legacy is secured and that your family's financial needs are met without the same tax implications that retirement accounts might incur upon your passing. If buying life insurance suits your situation and goals, consider the different types available. Comparing policies and rates from different insurance providers can help you find the best life insurance based on your needs.

Understanding the various 401(k) plans is key to maximizing your retirement savings potential. Each plan type is designed to cater to specific employment and financial situations.

• Traditional 401(k): A standard option where employees contribute pre-tax dollars, reducing their taxable income. Taxes on contributions and earnings are deferred until withdrawal in retirement.
• Roth 401(k): Contributions are made with after-tax dollars, offering tax-free growth and withdrawals, providing a tax advantage if you expect to be in a higher tax bracket during retirement.
• Safe Harbor 401(k): This plan is designed to satisfy non-discrimination tests automatically and requires employer contributions to be fully vested when made.
• SIMPLE 401(k): It is aimed at small businesses with fewer than 100 employees, and this plan simplifies the administrative burden and offers easier setup and maintenance than a standard 401(k).
• Solo 401(k): Tailored for self-employed individuals or business owners with no employees, allowing them to contribute as both employer and employee, maximizing retirement savings.
• Tiered Profit Sharing 401(k): Allows employers to make contributions based on a tiered structure, often tied to the company's profitability. This can boost employee retirement savings when the company does well.

Selecting the right type of life insurance policy depends on personal financial goals and needs. Each variety offers distinct benefits tailored to different planning strategies.

• Term Life Insurance: Provides coverage for a specific period, offering a death benefit if the policyholder passes away during the term. It's the most straightforward and affordable option, ideal for temporary coverage needs without a savings component.
• Whole Life Insurance: This is a form of permanent life insurance that offers a death benefit and a savings account. Premiums remain consistent, and the policy's cash value accumulates over time, serving as a potential source of funds.
• Universal Life Insurance: Offers flexible premiums and death benefits, with a savings component that earns interest. It allows policyholders to adjust their coverage as their financial situation changes.
• Variable Life Insurance: This features investment options that can grow the policy's cash value. The value can increase significantly with investment gains but also risks decline with market downturns.
• Indexed Universal Life Insurance: This ties cash value accumulation to a market index, balancing growth potential and protection against market loss. It's a middle ground for those seeking growth with some safeguards.
• Variable Universal Life Insurance: Combines the investment options of variable life with the flexibility of universal life. Policyholders can adjust premiums and death benefits while choosing how to invest the cash value.
• Final Expense Insurance: This insurance is designed to cover burial costs and final bills; this policy ensures that end-of-life expenses are not a burden to loved ones. It typically has lower coverage amounts and is easier to qualify for.
• Guaranteed Issue Life Insurance: Requires no medical exam and offers guaranteed coverage, typically for those with serious health issues. It's more expensive and offers lower benefits, addressing specific coverage needs where other policies may not be available.

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