Two important tools for your financial future are life insurance and a 401(k). Life insurance is a way to provide financially for your loved ones after you pass away, while a 401(k) is a company-sponsored savings account for your retirement funds. Which is better for retirement?The cash value of a permanent life insurance policy can be a great way to supplement your retirement savings, but shouldn’t be your only source of income after you stop working. Some life insurance policies, like a life insurance retirement plan (LIRP), can also help you save for retirement. However, a 401(k) typically makes more sense as your primary retirement income because it’s more affordable and offers better returns than a LIRP or other types of life insurance. In this article, we’ll help you understand the pros and cons of both life insurance and a 401(k) and how to support your retirement with a life insurance policy.
Pros and Cons of Life Insurance for Retirement
You’ll want to make sure your dependents and other loved ones are financially protected even through your retirement years, and life insurance is a great way to do so. The pros of life insurance for retirement include:
Financial protection for your loved ones: Life insurance can replace lost income and pay for outstanding debts, like a mortgage, if you were to pass away unexpectedly.
Tax-free benefits: Your death benefits won’t be taxed, helping your beneficiaries hold on to the full value of the policy.
Cash value: Unlike term life insurance, permanent life insurance policies, including life insurance retirement plans, have a cash value component that can be used as an investment tool, helping supplement your retirement income. The cash value is also typically easily accessible via withdrawal or a loan.
However, relying solely on life insurance for retirement does have drawbacks, including:
Premiums can be expensive: Life insurance premiums can be expensive, whereas you get to decide how much to contribute to your 401(k). This may make it easier to fit saving for retirement into your budget.
Savings potential isn’t as high as with a 401(k): 401(k) earnings compound over time, and some employers even offer a contribution match, so it’s usually the better option for savings potential compared to life insurance.
Investment options are limited: Compared to a 401(k), investment opportunities with the cash value of life insurance are not as diverse.
Pros and Cons of a 401(k) for Retirement
As a savings option designed specifically for retirement, 401(k)s have many benefits, including:
Better returns than life insurance: Because 401(k) contributions grow over time, the returns are more significant than the cash value of a life insurance policy.
More varied investment options: Compared to investment opportunities for life insurance, employers offer a more diverse portfolio of options for 401(k)s.
Earnings are tax-deferred: Your contributions are also made pre-tax, so you can deduct them to potentially reduce your amount of taxable income. You will be taxed on these assets when you withdraw them during retirement.
Convenience: 401(k) contributions are typically done via automatic deduction from your paycheck, allowing a hands-off approach to saving.
However, 401(k)s aren’t designed to meet every financial need or priority in retirement. Cons of a 401(k) being your only source of retirement funds include:
Withdrawal limits: 401(k) funds are typically only accessible once you’ve reached a certain age, with penalties for early withdrawal.
Contribution limits: The IRS limits the amount you and your employer can contribute to your 401k each year, whereas life insurance cash value has no accrual limit.
No death benefits: While a 401(k) can provide retirement income, it doesn’t replace the value of your lost income after your death, although you can leave the balance of your 401(k) to your loved ones if you were to pass away.
Supporting Your Retirement With a Life Insurance Policy
Overall, life insurance shouldn’t be the only tool in your only retirement plan, but it can be a source of additional income after you stop working. Think of it as a one-two punch: your 401(k) provides a solid base of retirement income, while the right life insurance policy can help supplement and boost that income. Permanent policies make the most sense to supplement your retirement, as they have a cash value component that term policies do not.You can also enroll in a life insurance retirement plan (LIRP). A specific benefit of a LIRP is that the policyholder can take out tax-free loans against the death benefit to supplement their income. Keep in mind that if you don't pay the loan back, the death benefit reduces, so this strategy makes the most sense if you’re using the LIRP as wealth management rather than a primary source of inheritance for your beneficiaries. The ways in which you can use cash value funds to support your retirement include:
Withdrawal: You can make tax-free withdrawals from the cash value of your policy.
Loans: You can borrow against the value of your policy as a loan. Keep in mind that if you don’t pay back the loan before you pass away, the outstanding balance will be taken from your death benefits.
Paying premiums: Some policies allow you to pay your premiums with your cash value, allowing you to save more money to spend in retirement.
Surrender value: If your savings are significant enough that you no longer need your policy to provide death benefits for your loved ones, you can give up your policy for a lump sum surrender value.
SelectQuote Can Answer Your Questions About Life Insurance and Retirement
Life insurance can be a valuable tool to add to your retirement portfolio, and we can help you get started. With nearly 40 years of industry experience, SelectQuote is an expert resource on life insurance and can help answer any questions you have. We can make the shopping process easier, too, by searching trusted carriers for you in just minutes.
