Understanding 401ks and Life Insurance

Planning for the future can be complicated, especially if you have a large number of assets and beneficiaries you want to care for when you are no longer alive. While many of us know planning for retirement is important, we often don’t know how to begin. At Clark Olson Law, we can guide you through preparing a 401k and life insurance policy to meet your financial goals while keeping your family’s best interests in mind.

What is a 401k?

A 401k is a qualified retirement plan that allows employees to invest for retirement on a tax-deferred basis. In essence, you decide how much money you want deducted from your paycheck each week to be deposited into your 401k. Depending on your employer, you may have limits on how much or how little you can put into your 401k in addition to IRS rules.

In many cases, your employer may contribute to your 401k, however, this is not mandatory.

When determining the percentage of your paycheck you want to be deposited into your 401k, it is important to remember that the more you contribute, the fewer taxes you are having taken out.

What happens is this: Say you make $950 in a pay period before taxes. You decide to have 5% taken out of your paycheck to be placed into your 401k. Your takehome pay is then $902.50. That remaining amount is what is taxed, not the total lump sum amount.

Many people believe that they should hold off on investing in their 401k, but that really is not true. The earlier you can begin to pay into a 401k, the better you will be when you come to retirement. If you only begin contributing in your near retirement years, your investment options will likely be limited to what safe options exist.

However, no one can tell you what to have deducted and when. It is up to you to weigh the costs and benefits.

What is a Life Insurance Policy?

A life insurance policy is much different than a 401k. Where a 401k provides for you when you can no longer work, a life insurance policy cares for your loved ones when you have passed.

In general, a life insurance policy is a contract with an insurance company that defines set payments over time which provides a death benefit to beneficiaries upon the insured’s death.

There are many types of life insurance policies that may be chosen from, however, it’s important to know which suits the needs of you and your family. But one thing to consider is this: death benefits from all types of life insurance policies are generally income tax-free, with some expectations.

Types of life insurance policies include:

  • Term Life Insurance: Though term life insurance is generally the cheapest form, it’s important to know how it works. You will select a set amount of time, say 10 or 20 years. If you were to pass during that time, it would offer a lost income payment to your beneficiaries in one lump sum. However, if you live past the term, you will be offered an extension, typically at a much higher premium rate.
  • Universal Life Insurance: If you are looking for a flexible option in your estate planning strategy, universal life insurance can help. This type of coverage allows you to change your premium payment depending on what is occurring. This can be used to provide death benefit coverage or building cash to beneficiaries.
  • Whole Life Insurance: Though similar to a universal life insurance policy, a whole life insurance policy has fixed premium payments and has a cash value that builds as tax-deferred over time.

It is critical to know that while there are tax incentives for having a life insurance policy, your overall cost will be determined based upon your current age and health, family health history, and lifestyle choices like smoking and drinking.

Which do I need?

Many estate planning attorneys will argue that it isn’t a horrible idea to have both a life insurance policy and 401k. Remember, the 401k is for you to retire with. The life insurance policy is for your family members when you are no longer able to provide for them.

However, it will ultimately come down to what your current goals are for the future and what type of assets and investments you would like to have available to you and/or your family.

Knowing what you need at this stage in life can be complicated. Clark Olson Law can help.

401ks and Life Insurance Policies: Clark Olson Law

If you need guidance preparing 401Ks, life insurance, and business interests, contact the tax and estate planning professionals of Clark Olson Law. Our attorneys will guide you through the process to ensure your needs are met and your family will be taken care of when you are no longer here. Contact us today to discuss your estate planning options.

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