Why I bought life insurance before contributing a penny to my 401(k) (2024)

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• My wife and I married in our early 20s, and when we started having kids, we decided she'd stay home to care for them while I worked to earn an income.
• Our finances were tight, so I had to decide between saving in a 401(k) and buying term life insurance.
• I ultimately bought life insurance because I knew that if I died unexpectedly, my family would be in grave financial danger. Once I was earning more, we started saving for retirement and diversified our investments.

My wife and I got married pretty young (I was 22 and she was 21). My wife worked a full-time job while I finished up my bachelor's degree. She was nine months pregnant on the day of my college graduation, and when our daughter was born, we decided that she would stay at home while I worked to support our family.

Young, married, and broke

Although we were fortunate to be able to live on only one income, it certainly did mean that things were tight. As one kid turned into two and then even more, we often had to make tough budget decisions. One of those decisions had to do with how to best plan for our future. One option was to contribute to retirement-specific accounts, like IRAs and 401(k) plans. Another possibility was to purchase life insurance.

While both retirement savings and life insurance play an important role in a healthy financial plan, at the time, it was more of an either/or decision. With not a lot of spare money left over at the end of each month, we were in a position where we had to choose where we wanted to invest first.

The answer may not be the same for everyone, but I'll walk through some of our thinking.

The case for maxing out my 401(k)

Probably the best reason for contributing to retirement accounts like IRAs and 401(k) plans is the seemingly magical power of compound interest. While compound interest is a bad thing when it comes to credit card debt and mortgage loans, it can be one of your biggest financial allies when you make it work for you. And the earlier you start, the more time you have to truly maximize the compounding of interest in your retirement account.

Here's a case study of three different investors: One starts saving $300 per month at the age of 25, the second waits 10 years, and starts saving $300 per month at 35. The third waits even longer and starts saving at 40, but in order to try to catch up, puts $600 into her account each month. It hopefully comes as no surprise that the investor who starts earlier has significantly more money by the time retirement comes around.

Another reason for contributing to your 401(k) is if your employer offers any matching funds. A typical scenario might be an employer that will match 100% of your contributions up to 3% of your salary. So your 3% gets a 100% return on your investment.

The case for buying life insurance

The case for buying life insurance comes down to one word — protection. All types of insurance are intended to protect you from unlikely outcomes that would have an outsized financial impact if they occurred. Car insurance protects you if you were to get into a car accident, home insurance protects you from fire, theft, or other catastrophes, and life insurance protects your family in case you die.

For many people, it's challenging to think about our own mortality, but if you are providing for a spouse or dependents, you owe it to them. Without question, the death of any loved one comes with untold emotional pain and suffering. You'll want to make sure that it doesn't also come with any type of financial suffering. And a meaningful life insurance policy may cost less than you think.

It is important to note the difference between term life insurance and whole life insurance. Term life insurance is focused solely on the "death benefit." You pay monthly premiums, and if you die before the "term" is up (usually 20 or 30 years), then the insurance company will pay your beneficiary the stated death benefit. Whole life insurance usually comes with significantly higher monthly premiums and is more of a hybrid between a term life insurance policy and a traditional retirement investment.

Why I chose life insurance

It makes the most sense to prioritize life insurance if you are in a situation where you have young children or a big imbalance in the earning potential of spouses. We were in just about the ideal situation to choose to put our extra money towards life insurance, since we had a stay-at-home spouse caring for several young kiddos.

I knew that, without life insurance, if I were to die unexpectedly, my wife and children would be in severe financial distress. A single person with no dependents or a couple with more equal earning potentials might have different answers. Take a look at your own situation and see what makes sense for you and your family.

Over the years, as my salary and other side hustles have increased our family's income, we've diversified our investments. In addition to life insurance, we have money saved for retirement, taxable investment accounts, and rental real estate (though I still haven't saved any money for college). But I won't forget the moment I understood how important life insurance was and the peace of mind it gave our young family.