To be honest, it’s an unfair question. Let me explain.
For those of you with kids, how would you answer a question about which child you love the most? “They are each very different, with their own strengths and weaknesses, but I love them both equally!”
Both a 401k and permanent life insurance are fine financial tools for a retirement plan. Let’s see what they are both about.
What is a 401k, and how does it help you?
When the 401k was created in the late 1970s, it was a revolutionary, employer-sponsored investment tool. The concept was simple: set aside a percentage of your regular paycheck in a retirement account that was tagged as “pre-tax” and let the investment and the gains grow tax-free until you reached age 59½.
Genius.
It is a great way to build retirement income. For example, If your salary is $60,000 and you invest 6% into a 401k, which is $3,600, your taxable income is reduced by $3,600. Think of it as funding your savings before paying yourself.
Today, a 401k remains one of the foundational tools of retirement and estate planning. For 2024, the maximum amount an individual can contribute to a 401k is $23,000. For those 50 and older, the maximum contribution is $30,500.
What is permanent life insurance, and how does it help you?
Permanent life insurance is an umbrella description for several different types of life insurance, such as a whole life policy, universal life, and indexed universal life insurance. The insurance coverage is designed to cover the policyholder’s entire life. Many life insurance companies offer these products.
In addition to the core insurance component, which provides a tax-free death benefit for your loved ones, permanent policies also include a cash value component, which includes investment options. The cash value is funded by a portion of your premium payment.
Conversely, there is no cash value component with term life insurance.
This may not fall into the genius category, but it is nonetheless an excellent tool to plan for your financial future.
Each permanent life insurance product has different options for investing the policy’s cash value component, from fixed rates of return to participation in the stock market. You choose the product with the risk profile that best fits your investment style for retirement funds.
So, which is better: 401k or life insurance?
Here we go again, asking which child I like better. Let’s dig a little deeper into how they stack up against each other.
Return on Investment
A 401k is typically considered the better option, primarily because your contributions grow over time (along with those from the employer match), and there are more investment options than with a permanent life insurance policy.
Market Fluctuations
Some 401ks and permanent life insurance cash value accounts are subject to market volatility. Some life insurance policies have options with guaranteed rates of return, which are typically lower than returns with stocks and bonds.
Income Taxes
Both have tax benefits. Contributions and interest earned in a 401k are tax-deferred until age 59½, when withdrawals are allowed with no penalty, according to the IRS. Cash value growth in life insurance typically accrues tax-free. And the death benefit of a life insurance policy that passes to your beneficiaries is typically tax-deductible.
Investment Amount
There are contribution limits with a 401k. The maximum amount for an individual in 2024 is $23,000, and $30,500 for a person 50 or older. While there are no limits on how much permanent life insurance you can purchase, premiums can be expensive. You can reduce the cost of life insurance premiums by buying less insurance, reducing the cash value the policy builds.
Access to Money
There is a 10% penalty for early withdrawal from a 401k before age 59½, with a few exceptions for extraordinary circumstances. With the cash value from a permanent life insurance policy, you have much easier access to the funds.
Death Benefit
A 401k does not have a tax-free death benefit like life insurance. There are no age or withdrawal-type restrictions on the death benefit with a life insurance policy other than the policy’s premium payments must be current for it to be paid to the beneficiaries.
Bottom Line: Both are excellent tools depending on your needs and finances.
To stay with our theme, the 401k and all types of permanent life insurance have strengths and weaknesses, but I love them both!
A 401k is an amazing tool for retirement savings.
Permanent life insurance is an amazing tool for estate and financial planning.
Either of these will provide peace of mind for you and your family. As always, seek the help of a qualified professional, either a licensed insurance agent or a financial advisor (or both).
