I was invited to participate in an expert response for moneygeek.com study.
Here is the question and my response. Which can be found at https://www.moneygeek.com/insurance/life/types/401k-vs-life/#expert=kaysian-gordon
Recently, some social media accounts have touted the value of insurance as a way to save for and fund retirement. Is this just marketing?
I view life insurance and retirement savings as two separate vehicles. When considering different products, before any product comes into the conversation, you should understand what you are looking to accomplish.
Life insurance is a great tool to protect the life of an income earner. The life insurance policy may have other features, aka “bells and whistles.” However, ultimately, life insurance should be for protection against losing an individual’s income while it is still needed to keep a family financially afloat. It also protects a family who might be grieving from having to worry about how the next bill will be paid or even how the final expenses of their loved one will be paid.
Typically, a life insurance policy is paid out upon the covered individual’s death. There might be other clauses that will help if the person has a terminal illness and is not expected to survive. The key is to understand what you are purchasing and the costs for additional features, also known as “riders” in the policy. How will the permanent policy be taxed if you take money out of it? For each decision you need to make, you should understand its taxability, weighing the costs against the benefits.
Often, when it’s being sold, you are told that you can take out loans; however, what does the loan do to the original policy? Will it significantly reduce the death benefit, which may be the original reason you purchased the policy?
In terms of saving for retirement, I believe this looks different. When you have a 401(k) or 403(B) or other retirement vehicle, the assets are liquid, meaning you can sell them and have the money within a week or so. Based on the rules set by the Internal Revenue Service (IRS), you know how much you are eligible to contribute each year based on the set maximums.
These contributions are invested automatically on your behalf, which allows for dollar cost averaging. You are investing in the stock market with each paycheck without contemplating what the market is doing. You have now eliminated some of the behavioral issues that might prevent us from investing if the market is down significantly, which is usually the best time to buy. Still, because of fear, that is usually the least likely time we would invest. With the automation of the contributions, we have eliminated the thought process.
This allows the 401(k) or 403(B) to perform more in line with the markets. The taxation when you choose to take money out is pretty straightforward. If you take money out before 59 ½ (except in a few circumstances), you will pay a 10% penalty plus ordinary income taxes. If you take it out after 59 ½, you must pay ordinary income taxes, depending on which tax bracket you fall into. And then, for a traditional retirement account (not ROTH), depending on the year you were born, when you are in your early 70s, you will be required to take a Required Minimum Distribution (RMD).
I believe a large part of showing insurance in retirement accounts versus funding traditional retirement plans on social media is marketing. The key is understanding what you want to accomplish before committing to a product. Please do some research and ask questions, and also understand what your underlying fees are. Life insurance products tend to be more expensive than retirement accounts over time, which also means your assets will grow less over time. This is why it’s important to understand what you want to accomplish before purchasing a policy or investing in retirement accounts.