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Life insurance vs. 401(k)

401(k)s are definitively a better investment. But you might want both for different reasons.

Life insurance and a 401(k): Which is the better investment? Both can help you grow your money and plan for the future. The fact is, most experts recommend opening a 401(k) first. But if you’re looking for additional investments, life insurance could be a good option.

What is life insurance?

Here’s life insurance in a nutshell.

First, you pay a premium to your insurer. This is the fee you pay to keep your life insurance policy active, and you typically pay it monthly or annually.

In return, your provider pays out a death benefit to your beneficiaries if you pass away while your policy is in effect.

  • A death benefit is a lump-sum payment from a provider when a policyholder passes away.
  • Beneficiaries are the people designated by the policyholder to receive the death benefit.

What you should know about life insurance

  • Life insurance falls into different types. Term life is one of the most common, providing temporary coverage for a set period of 5, 10, 15, 20, 25 or 30 years. Universal and whole life are also very common — they’re forms of permanent life insurance, which offer coverage for your entire life.
  • There’s a reason people often consider 401(k)s along with life insurance. Unlike term life insurance, permanent life insurance comes with an investment component called cash value. As you pay your premium, part of it goes toward your cash value. Your provider invests this money for you. Gains from cash value are tax-deferred, meaning they aren’t taxed until you withdraw them.

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What is a 401(k)?

When you’re hired for a job, you may be asked to participate in a 401(k). It’s an employer-sponsored account that helps you save for retirement.

When you sign up for it, money is automatically deducted from each of your paychecks and applied to your 401(k) account.

That’s one reason a 401(k) can be attractive: You’re saving without any effort on your part.

What you should know about a 401(k)

Beyond its hands-off nature, a 401(k) offers attractive benefits that include:

  • Potential free money. Many employers match the contributions you make to your 401(k). For example, your company might match each dollar you put into your 401(k) up to 3% of your pay. It’s like free money.
  • Ability to deduct contributions on your taxes. When you put money into a 401(k), it decreases your taxable income for the year. For example, if you make $50,000 yearly and contribute $15,000 into your 401(k), you’ll pay taxes only on $35,000.
  • Enjoy tax benefits. The money you put into a 401(k) is tax-deferred — meaning you don’t pay taxes on it until you withdraw it in retirement. And if you have a Roth 401(k), you won’t pay any taxes when you withdraw. That’s because you’ll make contributions with income you’ve already paid taxes on.

Should I buy life insurance or open a 401(k)?

Many experts say that a 401(k) is always a good choice. This is especially the case if your employer matches your contributions.

If you’re comparing life insurance and a 401(k), you’re probably looking at them in terms of investments.

In that case, the statistics work out in favor of the 401(k):

  • The cash value in whole life insurance — a form of permanent life insurance — generally garners a 1.5% to 3.5% yearly return.
  • Meanwhile, the average yearly return for a 401(k) is 5% to 8%.

Typically, experts recommend first contributing the maximum to your retirement accounts. For example, you’d contribute $18,500 a year to your 401(k) and $5,500 a year to your IRA. If you’re maxing out in those accounts, then it might make sense to buy permanent life insurance as an additional investment.

Can I get both?

Yes, you can absolutely get both life insurance and a 401(k).

Let’s say you’ve decided to open a 401(k). At this point, you may still want to consider life insurance. That’s because it’s primarily designed to provide for your family if the unthinkable were to happen to you.

For that purpose, term life insurance may be a good choice. It can offer peace of mind during your working years, when your spouse and children may depend on your income. At the same time, it’s often affordable for most budgets.
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According to our research, here’s the average monthly premium for a healthy 30-year-old nonsmoker who wants a 20-year, $500,000 term life policy:


Here’s the average monthly premium the same individual might pay for a $500,000 whole life policy:


Whole life insurance costs more than term life insurance. Many experts recommend buying term insurance for the death benefit, then investing what you otherwise would have paid for permanent insurance.

If you choose your investments carefully, you may get a much higher return than what permanent life insurance could offer.

Bottom line

It’s typically a good idea to get your 401(k) first and max out contributions to it. Then open an IRA and regularly make the maximum yearly contribution. If you need more investment vehicles, permanent life insurance can help you diversify.

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