Permanent life insurance comes with an investing feature, but you shouldn’t rely on it for retirement. A 401(k) is a more affordable option with better returns.
Published July 22, 2021|3 min read
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Most people save for retirement with a 401(k) offered by their employer or a Roth IRA,   and may supplement those savings with other traditional investment accounts. One additional option is to use a life insurance policy to save for retirement.
However, a 401(k) is a better retirement investment than a life insurance retirement plan (LIRP), because LIRPs have high premiums and a low return on investment. Saving for retirement isn’t one-size-fits-all, though. A LIRP can make sense for high-income earners with dependents who need lifelong financial support.
Permanent policies include a cash value account that earns tax-deferred interest over time
Most people shouldn’t use life insurance to save for retirement because earnings are low and permanent policies are expensive
Pairing a 401(k) or IRA with a term life policy is the most cost-effective option
High-income earners who need lifetime insurance coverage may consider buying a life policy to supplement their retirement savings
Cash value life insurance has two main advantages over a 401(k), but the disadvantages usually outweigh the benefits.
Guaranteed interest: Most policies offer at least a minimum interest of 0%, which 401(k) investments don’t have. This can protect you from losses in the event of an unexpected stock market downturn.
Liquidity: You can access the cash value of a policy at any time, whereas 401(k) withdrawals before age 59-½ will trigger a 10% penalty and income taxes. 
High fees: Management fees are often much higher than you’d find in a 401(k). Average fees for a 401(k) are approximately 0.50%,  whereas expenses and fees for a permanent policy like indexed universal life insurance can be 3% and up.
Low rates of return: Recent research found that over an eight-year period, employee 401(k)s grew by an average of 13.9% per year.  Compare that to a fixed interest rate of 2-3% on a permanent policy.
These differences add up over time. Applied to $50,000 in savings, the fees above would equal $250 per year in a 401(k) vs. $1,500 per year with life insurance. In the same vein, you could see investment growth of $6,950 a year at 13.9% interest compared to $1,500 per year at 3% interest, and you’d spend $729 more on life insurance each month to have whole life coverage.
Neither a Roth IRA nor a 401(k) are significantly better than the other for retirement savings. The main difference is that 401(k)s must be established by an employer, and IRAs are usually opened by individuals.
You may find one better for your financial situation based on the tax implications—you pay income tax on 401(k) withdrawals, but not Roth IRA withdrawals—or the annual contribution limits.  Many people find that it makes sense to use both, and both are preferable to using life insurance for retirement investing.
At minimum, you should be maxing out your retirement account contributions each year—that’s $19,500 for 401(k)s and $6,000 for Roth IRAs—before you consider a LIRP.  In most cases, it makes the most sense to factor in a LIRP if you also need lifetime coverage for estate tax or family care reasons.
The majority of people don’t need to use life insurance to supplement their retirement savings. Because permanent policies are five to 15 times more expensive than term policies, it’s much more cost-effective to invest in a separate retirement account or post-tax investment account and buy affordable, easy-to-cancel term life insurance coverage.
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If you choose to include life insurance in your retirement plan, you’ll need to buy a permanent insurance policy. Each type of policy has different features and, most importantly, earns interest in a different way.
Traditional whole life insurance is the most stable and least complicated investment, but will likely gain less interest than a riskier universal life insurance plan. A financial advisor or independent insurance agent can help you choose the right policy for your family’s needs and your tolerance for investment risk.
There are a few ways you can use cash value funds to support your retirement:
Cash value withdrawal: With some policies, like universal life, you can make withdrawals from your cash value. Withdrawals are tax-free up to the amount you’ve paid in premiums.
Policy loan: A life insurance loan doesn’t come directly out of your cash value. Instead, the account is used as collateral. You can’t borrow more than you have in your account, and if unpaid interest pushes you above that amount, your policy will lapse.
Premium payments: Some permanent policies also allow you to pay your premiums using your cash value, which frees up that money for your retirement spending.
Reduced paid-up insurance: Another way to stop paying your premiums, this option allows you to use your cash value to purchase a smaller, fully paid policy.
Surrender for cash: If you no longer need life insurance coverage (most people need significantly less, if any, in retirement), you can give up your policy and take the cash surrender value as a lump-sum payout.
You can use cash value funds in retirement to take out a loan, reduce your premium payments, or make withdrawals. If you don’t need coverage anymore, you can cancel your policy for a lump-sum payout.
Unlike a 401(k), there’s no penalty for withdrawing from your cash value account before a certain age. But, you are taxed on withdrawals from your cash value much like you are taxed on qualifying 401(k) withdrawals.
You are not taxed on withdrawals or policy surrenders with a value lower than the amount you’ve paid into the policy so far (known as the cost basis of your policy). But, withdrawals above that amount are taxed as income.
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When prioritizing retirement savings, a 401(k) is always a better choice than a life insurance policy. Even if you would benefit from a LIRP, you should maximize contributions to your 401(k) and other retirement accounts before investing in alternatives.
LIRPs require you to own a permanent life insurance policy, which is significantly more expensive than term life insurance coverage. In exchange for the higher premiums, you get lifetime insurance coverage (so your family gets a benefit no matter when you die) and a cash value account that earns interest over time. But, most people don’t need either of those features and will save more by buying an affordable term life policy while investing in traditional retirement funds.
You need life insurance unless you’ve saved enough money to cover funeral costs and debts and provide for any dependents after your death.
A 401(k) provides you with income in your retirement years, and life insurance provides financial support for your loved ones after you die.
Most people shouldn’t include life insurance in their retirement investing plans. Those that do should also have traditional retirement savings accounts.