401K vs Life Insurance: Which Is the Better Investment?

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Two common savings options are 401K retirement plans and life insurance policies. Both play an important part in creating a strong financial plan that will suit your needs as you age. A 401K plan is ideal for building retirement savings with tax advantages, especially if you’re eligible for matching employer contributions. Meanwhile, life insurance provides financial protection for dependents but can also work as an additional investment vehicle if you buy the right type of plan. Deciding between a 401K and life insurance, or how to balance both, depends on individual financial goals, age, health, income and dependents’ needs. If you can afford it, having both is ideal. Here’s more..

Key Takeaways

  • A 401K plan is a great way to save for retirement, especially if your employer matches your contributions.
  • A term life insurance policy does not have a savings account.
  • A permanent life insurance policy has a savings account but it must be repaid or it may result in costly premiums or deductions from the death benefit.
  • A life insurance policy takes care of dependents if you pass, and a policy with a cash value can serve as a low-cost loan, while a 401K plan is a retirement savings.

Understanding the Basics of a 401K and Life Insurance

What Is a 401k Plan?

A 401K plan is a retirement savings plan sponsored by an employer, who may also match a certain percentage of your pre-taxes deductions. Taxes are only applied when the money is withdrawn from the account.

What Is a Roth IRA?

A Roth IRA (Individual Retirement Account) is a type of retirement savings account that offers tax-free growth and tax-free withdrawals at retirement. Taxes, however, are deducted from contributions made to the Roth account.

Traditional 401K

Roth IRA

Contributions are made with pre-tax dollars

Contributions are made with after-tax dollars

Reduced taxable income

Tax-free growth

Pay taxes when you withdraw

Withdrawals during retirement are tax-free

$23,000 limit for a 401K plan for those under age 50; $30,500 for 50+

$7,000 contribution limit for those under age 50; $8,000 limit for 50+.

What Is Life Insurance?

Life insurance is a contract to pay premiums in return for a death benefit to be paid to designated beneficiaries after the policyholder dies. Life insurance can also include investment components, depending on the type of policy you choose. A permanent life insurance policy, for instance, has a cash savings that grows over time. You can borrow against that cash value but if you don’t repay it, it may be deducted from the death benefit.

2 Types of Life Insurance

There are two types of life insurance but many varieties of permanent life insurance policies. Here’s more:

  1. Term Life Insurance provides coverage for a specified period, usually 10, 20, or 30 years. It pays a death benefit if the policyholder dies within the term.
  2. Permanent Life Insurance includes whole life, universal life, and variable life insurance. These policies provide lifelong coverage and have a cash value component that grows over time.


Coverage for a Limited Term

Benefits Paid When You Pass Away

Cash Value in Addition to Death Benefit?

Low Cost

Term Life Insurance





Whole Life Insurance





Universal Life Insurance





Guaranteed Universal Life Insurance





Variable Universal Life Insurance





Indexed Universal Life Insurance





401K Vs Life Insurance: Which Is Better for You?

Saving for retirement is not a one-size-fits-all prospect. It’s important to consider your needs and goals before you choose whether to contribute more to your 401K or to buy a life insurance policy. Here are some things to consider:

Purpose and Goals

A 401K plan is designed for retirement savings whereas a life insurance policy is designed to provide financial security for beneficiaries in the event of the policyholder's death. Permanent life insurance can also serve as a savings and investment vehicle but with limited usage. If you borrow against a life insurance policy and don’t pay it back, it’ll be deducted from the death benefit and you may run the risk of having inadequate savings to pay the premiums. Monthly premium costs only rise as you age, so you run the risk of inactivating coverage by not being able to make the monthly payments.

Tax Savings

Contributions to a traditional 401K plan and employer-matched contributions are tax-deferred, meaning that less of your income will be taxed, but withdrawals are taxed as income. Roth 401K contributions do not reduce taxable income, but withdrawals are tax-free.

Death benefits for a life insurance policy are generally tax-free to beneficiaries. The cash value in permanent life insurance grows on a tax-deferred basis. Also, loans or withdrawals from the cash value may be tax-free.

Investment Growth

When you contribute to a 401K, you’re investing in one or more of the following: mutual funds, stocks, bonds and other securities. Growth of the account depends on market performance but is usually low-risk..

With a term-life policy there is no investment, no cash value. However, with a permanent life insurance policy, the cash value grows over time, either at a fixed rate or based on market performance, depending on the policy type you choose when you buy it.

Accessibility of Funds

There is a penalty for withdrawing funds from a 401K plan before age 59½. You’ll also have to pay taxes.

Term life insurance has no cash value, so you can’t cash it in. Permanent life insurance allows access to the cash value through loans or withdrawals, often without penalties, but under the condition that you pay it back or else your account won’t pay its own premiums or it’ll be deducted from the death benefit you’re leaving to designated beneficiaries.

Pros and Cons of a 401K Plan

Pros of a 401K

Cons of a 401K

Employer Contributions

Limited Investment Choices

Tax Benefits

Early Withdrawal Penalties*

Higher Contribution Limits

Market Risk**

Automatic Deductions From Paycheck


*Withdrawing funds before age 59½ typically incurs a 10% penalty plus income tax.

**Total savings fluctuate according to markets and inflation.

Pros and Cons of a Life Insurance Policy

Pros of a Life Insurance Policy

Cons of a Life Insurance Policy

Financial Security for Dependents

High Cost

Tax Benefits for Policyholder + Beneficiary


Access to Cash Value

Lower Return on Investment

Lifelong Coverage


Cash Value Can Pay Premiums Over Time


Factors to Consider When Choosing Between a 401K and Life Insurance

Financial Goals

  • If your main goal is to save for retirement, a 401K is the better option due to its tax benefits and higher contribution limits.
  • If your main goal is to ensure financial security for your dependents after you pass, life insurance is more important. Term life insurance is very affordable, so you can easily contribute to a 401K while paying insurance premiums.
  • A permanent life insurance offers lifelong protection and a cash value component, which may be helpful for home renovations, starting or funding a business and more.

Age and Health

  • Younger individuals with fewer health issues may benefit from starting with a 401K to take advantage of compound growth over time.
  • Younger individuals and new families can buy term life insurance can be added for for coverage at low rates
  • Older individuals pay a lot for life insurance, and health issues may price them out of a permanent life insurance policy. It’s a good idea to buy one while you’re still young so the cash value pays the premiums when you’re no longer young.

Income and Budget

Higher Income: Those with higher incomes may benefit from the tax deferral of a 401(k) and the potential for employer matching contributions.

Budget Constraints: Term life insurance offers affordable coverage for those with budget constraints, while permanent life insurance and 401(k) contributions can be considered as income grows.

The Ideal Investment: Combining 401K and Life Insurance

The best thing to do is to start a 401K plan as your primary savings while buying a life insurance policy. If your employer matches contributions, you’d be leaving money on the table if you do not utilize the 401K benefit and you’ll be paying taxes on money you could be putting away towards the future.

If you can only afford a term life policy, consider buying a convertible one so you can transition to a permanent policy to grow a savings account. Just make sure you’re covered during critical years, like while children are young or mortgages are outstanding. A permanent life insurance policy can also provide tax benefits.

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401K Vs Life Insurance FAQs

What are required minimum distributions (RMDs)?

RMDs are mandatory, minimum annual withdrawals that must begin at age 73. The amount is based on your account balance and life expectancy.

Can I contribute to both a 401K and an IRA?

You can contribute to both a 401K and an IRA, but there will be contribution limits and income restrictions.

How does a loan against a life insurance policy work?

You can borrow against the cash value of your life insurance policy. The loan is tax-free as long as the policy remains in force. However, you must pay interest on the loan, and unpaid loans can reduce the death benefit.


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