Life Insurance or 401(k)?

Life Insurance or 401(k)?

I love reader questions – and always jump at the chance to answer them.

Today’s question comes from Phillip. Phillip just had his first kid, Alexander. Being a good parent, Phillip is making progress towards three vital things for new parents:

  • 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

Finding the best life insurance policy is important because it’s 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 its 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.

Life Insurance Scenarios - Fee-only Financial Planners & Fiduciaries at Define Financial

Life Insurance Scenarios

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.

Life Insurance or 401(k)? Fee-only financial planners & fiduciaries at Define Financial.


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 (i.e. whole life, universal life, variable life).