401(k) vs. Life Insurance: Which One 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. 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.

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.

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.

  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.

    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. 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.

Experts' Advice About Choosing Between 401(k) and Life Insurance

Our research indicates some consumers are considering whether to fund a 401(k) or permanent life insurance as a means of retirement planning. Why might they be making this comparison?

Many investors may make this comparison because similar tax advantages are available within a life insurance policy as within a 401(K) plan. Additionally, both can be used for long-term investing and retirement planning. The most accurate comparison should be between a Roth IRA and/or a Roth 401(K).

Recently, some social media accounts have touted the value of insurance as a way to save for and fund retirement. Is this just marketing?

While there are tax advantages to using life insurance for investment purposes and for retirement planning and allotment of individuals that are generally not securities licensed to tout this strategy on social media, investors need to truly understand how it works, how the policies function, the costs associated with it and they need to truly make sure the policies are built correctly for what they want to accomplish. So, in some way, yes, this is just marketing; however, in other ways, if an investor is doing all the other things they should be doing to alleviate taxes and save more for retirement, then technically, life insurance can be an adequate vehicle to facilitate this.

How do the contributions and contribution limits for a 401(k) compare to premium payments for life insurance?

Technically, there are no contribution limits for life insurance other than the constraints one may have related to the amount of death benefit. Whereas there are limits to IRAs and 401(K)s, our stance, however, mainly due to the added costs and fees associated with this type of strategy, is that you generally should only consider this type of strategy after you have already maxed out your 401(K)/Roth 401(K) and your IRA, or if you are in a very cash-intensive small business and don’t qualify for large retirement plan contributions.

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