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

For most people, their 401(k) or home is the main investment that they’ll rely on in retirement. But are these your only options?

A life insurance policy is an alternative way to save for your later years. It’s not an investment, but it can provide similar benefits as a 401(k). 

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What’s the Difference Between Life Insurance and a 401(k)?

A 401(k) is a retirement savings plan offered by employers. Contributions are made directly from your paycheck and come with tax benefits. An employer match is part of your overall compensation package.

Money saved in a 401(k) can be invested in securities like stocks, bonds, mutual funds, and exchange-traded funds (ETFs), with mutual funds being one of the more popular options. These investments allow you to grow your savings over time.

Life insurance is technically not an investment. Rather, it’s a policy that can provide financial protection for your loved ones when you die. A death benefit payment can be used to cover funeral costs, living expenses, and educational needs, and compensate for the loss of missed earnings. 

Both 401(k)s and life insurance policies come with fees: 

• In a 401(k), a fund will typically charge an administrative fee that’s a percentage of your investment. If you’re not mindful of the fees they can erode your savings.
• A life insurance policy charges a monthly premium. The premium is allocated towards insurance coverage, administrative fees, cash value, and, with some policies, a commission for the sales broker.

Life insurance as retirement savings

Life insurance doesn’t just have to be for after your death. 

A cash value can build up in a permanent life insurance policy, which you can withdraw from while you’re alive. Interest can accrue on the policy and compound over time. 

This is one reason why some people consider life insurance to be an investment. 

Also, some types of policies are flexible and come with more opportunities to increase the policy’s value. 

For example, a universal policy can earn interest and may track a market index, while a variable policy can be tied to an underlying asset that moves with the market.

The catch is that you’ll pay a fee for withdrawing early (i.e., before your death). As well, if you withdraw more than you paid into the policy, you may owe taxes on the money you take out.

Lastly, withdrawing from your life insurance policy means there will be less money to support your loved ones after you die.

RELATED: Why You Need Life Insurance as a Parent

401(k) Plans vs. Life Insurance Plans

There are multiple types of 401(k) plans to choose from for retirement. But if you want to use life insurance to fund your retirement, that can only be done with permanent life insurance.

Types of 401(k) plans

• Traditional 401(k): Earnings grow tax-deferred until retirement. When you begin taking distributions, those distributions will be taxed as ordinary income.
• Roth 401(k): You pay taxes upfront, so your earnings grow tax-free and you won’t be required to pay taxes on distributions in retirement.
• Solo 401(k): A retirement savings plan for self-employed individuals or business owners with no employees. It allows you to make contributions as both an employee and a business owner.

Types of life insurance plans

• Term life insurance: Usually has a lower premium but only provides coverage for a specific period. If you outlive the policy you won’t have to continue paying premiums but your loved ones won’t receive a death benefit when you pass either.
• Permanent/whole life insurance: The death benefit doesn’t end when you die. Premiums tend to be more expensive but the policy can increase in value over time.

Remember, you can only withdraw early from a permanent life insurance policy — and you will be charged a penalty.

RELATED: When Should I Make a Will?

Other Options for Retirement

While both a 401(k) and a life insurance policy can help cover expenses after you retire, they aren’t your only retirement savings option.

IRA

An IRA allows you to make tax-deductible contributions. 

A traditional IRA gives you more flexibility than a 401(k) over what types of securities you can invest in, while a Roth IRA allows you to benefit from tax-free growth. 

READ MORE: IRA vs. 401(k): Which One Is Better for You?

HSA

A health savings account (HSA) is a tax-advantaged savings account for medical expenses. 

It is a triple-benefited account which means contributions, earnings, and withdrawals are all tax-free.

RELATED: How to Use Your HSA to Unlock Preventative Care Savings

Annuity

An annuity is a financial product that’s similar to a life insurance policy. 

It’s a contract between you and an insurance company that also provides guaranteed payments in retirement. 

READ MORE: How To Save for Retirement

TL;DR: Which Is Better to Save for Retirement?

There isn’t a right or wrong way to save for retirement. It’s up to your needs and financial goals.

A life insurance policy can give you peace of mind that you won’t saddle your loved ones with debt after you pass away. Meanwhile, a 401(k) comes with tax benefits that you can capitalize on during your working career.

If you don’t have access to a 401(k), there are other options besides life insurance, like an IRA, HSA, or annuities.

To figure out what’s best for you, calculate how much cash you think you’ll need in retirement and how much you want to leave behind for your loved ones when you’re gone.

For more tips on managing your money for your future, check out these episodes of the Erika Taught Me podcast:

• How To Invest for Beginners (Step by Step)
• 10 Steps Towards Financial Wholeness
• Why Getting Rich is Easy And Being Patient is So Hard

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