Do You Need Life Insurance if You Have a 401(k)?

What Is a 401(k)?

A 401(k) is a tax-advantaged retirement plan provided by your employer. It offers pretax contributions, tax-deferred earnings and, often, employer matching. These combined benefits allow you to maximize your retirement savings. You can channel more money into your 401(k), thanks to tax savings and employer matching dollars. You don't pay taxes on earnings, so all of your money stays in your account to compound and grow.

One downside is that 401(k) withdrawals are fully taxable. If your beneficiaries use 401(k) funds to cover your final expenses and outstanding debts, they'll need to pay regular income taxes on the full amount they withdraw.

Learn more:Is a 401(k) Worth It?

What Is Life Insurance?

Life insurance provides tax-free funds to your beneficiaries when you die. A life insurance contract requires you pay premiums to an insurance company in exchange for a designated benefit that's paid when you pass away. Life insurance funds can be used to pay off your debts and final expenses, and act as a financial cushion for your heirs.

There are two basic types of life insurance, term life and whole life:

• Term life insurance covers a limited time period, typically one to 30 years. At the end of the policy's term, your coverage ends, though you may be able to renew your policy, purchase a new one or convert to a whole life policy.
• Whole life insurance is a type of permanent life insurance that remains in force for as long as you continue to pay your premiums. This type of insurance also accumulates a cash value that grows tax-deferred at a guaranteed rate. You can borrow against your cash value or withdraw it, though doing so may reduce the payout your beneficiaries receive when you die.

Unlike money withdrawn from a 401(k), life insurance benefits are not taxable. None of the money your beneficiaries receive from a life insurance payout will need to be allocated to the IRS, which means the money they receive goes farther.

Learn more:Which Is Better: Term or Whole Life Insurance?

Do You Need Life Insurance if You Have a 401(k)?

If you already have a 401(k) or other retirement account, you may not need life insurance, but you might consider adding it as a safeguard for your beneficiaries. Here are a few scenarios to consider:

• You have a spouse or dependents who need support. Life insurance can provide the additional funds your family would need if you were no longer there to contribute financially. This can be especially crucial if you haven't had decades to grow your 401(k) yet—precisely the time in life when you may have young children who will need support for many years to come.
• You want to ensure your final expenses are covered. When you don't have enough retirement funds to cover your final expenses or you don't want your heirs to have to dip into your retirement accounts, life insurance provides immediate funding without a tax consequence.
• You want to provide supplementary tax-free funds. Even if your beneficiaries are no longer dependent on you for support, life insurance adds to your legacy. With life insurance, you can be sure your heirs will receive an inheritance, even if your cash and retirement funds are depleted later in life.

Tip: Many employers offer group term life insurance as an employee benefit. Though this type of insurance is usually limited, it can provide welcome funds at a time of need, and you may be able to expand coverage at an additional cost if you want it.

How to Get Life Insurance

Shopping for life insurance can be a bit more complicated than shopping for auto or home insurance. Be prepared to provide information about yourself and for the process to take a few days to a few weeks to complete. Here are the basic steps to follow:

1. Decide how much life insurance you need. One common method suggests multiplying your annual salary times 10, 20 or 30 to calculate your benefit. You may also want to factor in the amount of your mortgage, projected college expenses for your children or anticipated caregiving costs for a loved one.
2. Choose term or whole life insurance. Decide whether you want life insurance that expires after 10, 20 or 30 years, or whole life insurance that continues for as long as you maintain the policy in force. Costs may differ considerably: Whole life insurance may cost six to 10 times as much as term life, according to Guardian Life.
3. Compare quotes from multiple providers. You can get life insurance quotes from an online marketplace, insurance agent or broker, or a specific life insurance company.
4. Complete the application process. Applying for life insurance is a multistep process. In addition to answering questions about your health and lifestyle, you may need to complete a medical exam and a phone interview as part of the underwriting process.
5. Get final details and sign. You'll get final word on your policy and rate after you've gone through the underwriting process. Ask any questions you have and accept the terms if everything looks correct.

Learn more:How Much Life Insurance Do I Need?

The Bottom Line

Life insurance and 401(k) plans are two different financial planning tools that serve two different purposes: One doesn't replace the other. However, you may decide you need both a 401(k) and life insurance if you have dependents who'll need support in your absence, or you want your beneficiaries to have immediate access to tax-free funds when you pass.

Estate planning can be complicated. You have many options to choose from, and your needs are likely to evolve over time. Consider working with a financial planner or attorney specializing in estate planning to create a comprehensive plan that adapts as your life circumstances change.