I love reader questions – and always jump at the chance to answer them.
- Life Insurance
- Disability Insurance
- A Will
Like any budget-conscious person, Phillip is aghast at the cost of the insurance policies he now desperately needs. He shared his concern with me, saying:
Life insurance is expensive. Aren’t I better off putting this money into my 401(k) to save for retirement?
That’s an absolutely fantastic question. And here’s the answer:
Intrigued? Me too! Let’s discuss why.
Life Insurance and 401(k) scenarios
Life insurance can be a big expense. For Phillip, he’s looking at a bill of $700 every year! That’s a lot of money.
Phillip has a good point about investing the $700. Were he to put that $700 into his 401(k) account, he’d be looking at an extra $50,525 in his retirement account. (This assumes 20 years of $700 inflows, and compound growth of 5% for 35 years.)
An extra $50,000 on Day One of retirement provides a retirement budget increase of $1,500 a year. (This assumes a 3% withdrawal rate.) Therefore, re-purposing Phillip’s life insurance budget to fund his 401(k) gives Phillip a best-case scenario of having a little bit extra spending money in retirement.
But – what happens if Phillip dies without a life insurance policy? Phillip’s family just lost half it’s income. Phillip’s wife, Olympia, must now raise little Alexander not only as a single parent – but with much less money than what the family is accustomed to.
Let’s look at a different scenario. This time Phillip buys life insurance and contributes less to his 401(k). In a best-case scenario, Phillip lives to the ripe old age of 100 – having never used his life insurance policy. His spending in retirement is a little bit less than what it could have been, given that Phillip now has $50,000 less in his retirement account.
In a worst-case scenario, an assassin murders Phillip. Fortunately, the life insurance policy pays out to Olympia. This gives Olympia ample resources to provide for little Alexander.
Given the variables – there are four possible outcomes. For the two outcomes where Phillip lives to 100, the differences are not very big: a small change in lifestyle during retirement.
For the two other outcomes – where Phillip dies prematurely – the differences are very big. There will be a significant impact on the quality of life that Phillip’s family has.
So, while life insurance can be expensive – it is very necessary if you’re a breadwinner and parent of a minor.
To get the best deal on life insurance, always opt for a term life policy and skip permanent polices. Avoid whole life, universal life and variable life.