If you have people in your life who depend on you financially, then it's generally a good idea to put some sort of life insurance policy in place. That way, in the event of your sudden passing, your beneficiaries will be entitled to a payday that could help them survive in the absence of your income.
You may be of the impression that whole life insurance is a better bet for you than term life. And if you're going to pay up for a whole life policy, you might assume that it's better to focus on that and forgo contributions to a retirement plan like an IRA or 401(k). But that line of thinking could come back to haunt you.
Image source: Getty Images.
Why whole life insurance shouldn't be your sole retirement savings solution
Term life insurance, as the name implies, covers you for a certain term. It could be 10 years, 20 years, or more.
Whole life insurance, on the other hand, covers you indefinitely. Not only that, but whole life insurance accumulates a cash value over time, whereas term life insurance does not. This means that you may, as a retiree, have the option to cash out a whole life insurance policy when you need money.
As such, you might think whole life insurance could take the place of actual retirement savings. But that line of thinking could hurt you.
For one thing, if you spend years paying for whole life insurance instead of funding a retirement plan, you'll miss out on years of compounded returns in your IRA or 401(k). And while whole life insurance does build a cash value in time, the rate of return on a whole life policy might pale in comparison to the return you're able to get in a retirement portfolio you assemble yourself. (And even if you're hardly a stock-picking expert, a portfolio of S&P 500 index funds might do a lot better over time than a whole life insurance policy in terms of growth.)
Also, because whole life insurance can be prohibitively expensive, there's always the risk of having your policy lapse because of your inability to pay. So that could mean forgoing your coverage and losing out on the chance to cash it out.
It doesn't have to be one or the other
Whole life insurance could complement your IRA or 401(k) and serve as a backup source of retirement income should you need it. But it most certainly should not take the place of an actual nest egg you build.
So before you commit to a whole life policy, consider that the money coming out of your checking account to pay your premiums could instead go into an IRA or 401(k), which might offer you more financial benefit when you're older. And even if you're confident you can afford to retain whole life insurance for the long haul, you shouldn't let the cost of those premiums eat up so much of your income that you're unable to contribute to a retirement plan separately.
Remember, too, that funding an IRA or 401(k) -- at least the traditional version of each -- could shield some of your income from taxes. You don't get a tax break for paying life insurance premiums, though. So that's a peripheral but important reason not to let whole life insurance take the place of an actual retirement account you contribute to.
