Licensed insurance agents, out to sell more life insurance, are promoting both the Bank on Yourself and Infinite Banking concepts to explain how people can bypass banks and become their own source of money by utilizing a traditional whole life policy structured properly.
The idea behind Infinite Banking and the Bank on Yourself concept is a person can reach all their financial goals (retirement planning, college education, and even buying cars) simply by borrowing “from” the cash value of a whole life policy and paying themselves back the interest on the loan instead of paying interest to a bank. Sounds wonderful, doesn’t it?
An insurance agent promoting it may state this “safe wealth-building method” is possible because whole life insurance is unique because it allows a person to borrow money from their life policy but continue earning interest with that same money inside the policy; therefore using your money in two different places at the same time.
To make it even sound better, the insurance agent will explain when the contract owners pays any loan interest back to the policy, they will be paying that interest back to themselves instead of to a bank, thus building their own financial future and not enriching the bankers.
If these claims were true, it would make these strategies AWESOME. Who doesn’t want the power to create money out of thin air? Who doesn’t want to screw banks out of making more money.
As a matter of fact, when these strategies were first explained to me, I was like “damn, this is great!” As a life insurance agent myself, I wanted it to be true so I may have had a little “confirmation bias” in my assessment. However, as I stated to look into using whole life insurance to become my own banker, I realized that the claims these two systems of building wealth aren’t true. I am not saying it they are a scam, but they aren’t the best way to utilize the features and benefits of whole life insurance.
So, in this article, I am going to explain how these concepts presented in the Infinite Banking and Bank on Yourself strategies are perversions of how whole life insurance works. When you own a whole life insurance policy, you aren’t creating money out of thin air when you borrow from and you aren’t going to bypass Wall Street either. The fact is mutual insurance companies, which are the companies who underwrite the participating whole life insurance policies utilized by Bank on Yourself and Infinite Banking practitioners, are an integral part of the global financial system too.
Before I start getting into this article, I want to say I am a huge advocate of incorporating whole life insurance into a comprehensive financial plan because of its protection benefits, predictable growth of its cash value with additional growth through dividends paid as a return of premium payments, the tax-free access of borrowed money and the asset protection current tax law grants these contracts.
The difference between what I promote and what the financial advisors who promote Bank on Yourself and Infinite Banking are advising their clients is they believe the cash value of a life insurance policy is the FIRST place someone should borrow money from when they need it. I am going to explain in this article why the cash value of life insurance should be the LAST place to get money, why you should always borrow money from other outside sources before taping into a whole life policy, and a more efficient way to borrow your own money and still earn a rate of return if that is all you are looking to do.
My reasoning for making the cash value of a whole life insurance the last place to get money when you want it is all about flexibility, control, and transferring risk to those very same financial institutions Bank on Yourself and Infinite Banking are telling you that you can bypass using their strategy. You can’t bypass them to build wealth in today’s financial system. Instead, you learn to exploit them for everything they can give you and do what you can to shift as much risk away from yourself. Let’s get into this and I will explain in detail.
How banks create money - The fractional banking system
Since Bank on Yourself and Infinite Banking are selling consumers on becoming their own banks, I believe it is necessary to start with some background on how banks work and create money through the fractional banking system. This way, you can understand Bank on Yourself and Infinite Banking aren’t helping policy owners make money by borrowing from their policy. Instead, they are just playing a shell game with their own money when they borrow from a policy and pay back the interest and there may be better ways to access money that is cheaper and less risky.
Banks are the only financial institutions that can create money. Life insurance companies are the only financial institutions that create death benefits. The cash values and benefits of whole life can be leveraged to create wealth, just not to create wealth by borrowing and pay yourself the interest from your loans. I understand how people believe this is possible, but their misguidance is missing some simple key elements,
Banks make money today using a system called fractional banking. Fractional banking allows banks to lend out more money than they have deposited in their vaults, and they can charge interest on those loans to generate profits. Wouldn’t it be awesome if you could lend money you didn’t have to earn profits? Well, you can ONLY if you own a real bank, not a life insurance policy.
Here’s how fractional banking works:
Say a bank has $100 in deposits. That is all the money they have right now.
Under the fractional banking system, that bank can lend out $90 of that $100 (90% of the deposit), charging interest to make money on that loan. Most loans aren’t given to the borrower in cash and are instead credited to a deposit account. Therefore, in this example, the bank creates a new account and puts $90 in it for the new borrower. Now they have a total of $190 deposited and $90 in loans they have made.
This additional $90 deposit, which didn’t exist a few minutes ago, allows the bank to lend another $81 out and, of course, charge interest against the loan…
Then this $81 is deposited into the banking system, and the bank can again lend out $72…charging interest.
This continues until there are about $10 loans for every original $1 deposited. This is why people say that “banking is making money out of thin air.”
The thinking is that as long as enough people keep their money deposited in the bank to cover cash withdrawals, the system will work
Now that you understand how banks make money with fractional banking let’s explore mutual insurance companies and how they make money.
What is a mutual insurance company, and how do they make money
I love using a MUTUAL INSURANCE COMPANY for my own insurance needs. This is because these companies are not in business to make a profit for shareholders. Instead, they are in business to provide insurance coverage to their owners at the lowest possible long-term cost. Their mission aligns with my values. Regarding life policies, whole life policy owners are the owners of a mutual life insurance company.
I have worked with thousands of people, and I know buying insurance isn’t something that excites people. They do it because they either have to (like buying car insurance if they want to drive) or they do it because they feel it is the responsible thing to do (which, from a financial planning standpoint, it is.)
I can tell you that nobody plans on actually using the insurance benefits when they buy a policy (i.e. – they don’t plan on getting into a car accident or in regards to buying life insurance, dying anytime soon), and if you ask them, they’d probably much rather do something else with the money they use to pay premiums so they are reluctant to buy the insurance and will think about whether it is even necessary.
In fact, most people feel that buying insurance is a little like gambling. The big difference being when buying insurance, they don’t want to receive a payout, whereas when gambling, they do.
This is a purchasing constraint that many financial representatives who sell life insurance using the Bank on Yourself and Infinite Banking systems like to say is a positive result of people buying life insurance to bypass banks and be their own bank instead. The thinking is people will get the coverage they need and feel like they are using the insurance policy they purchased now to create the financial security they desire. The problem from a financial planning perspective is the thinking of how to use this financial product is wrong. I wish it were true, but it isn’t.
Mutual Life Insurance Investments and loans on whole life insurance policies
Mutual life insurance companies make Billions of dollars for their owners and operate all kinds of “for-profit” enterprises. They are part of the global financial system.
When a whole life insurance policy owner pays premiums, the mutual company uses it to provide insurance benefits, and they invest the excess premiums collected into a portfolio that consists of:
These investments and the cash flows they provide are used to create both the insurance company’s reserves, which are allocated to pay future potential claims, AND the cash values of the policies owned by the policy owners. As the cash value of each policy increases, the amount at risk to the insurance company is reduced because the insurance company is only going to create a death benefit which is the difference between the cash value and the face amount of the insurance policy. The higher the cash value and the closer it is to the death benefit, the less risk to the insurance company.
The big thing I want you to realize right now is mutual insurance companies, like banks, provide financing for businesses and governments. The bonds they invest in are debt instruments companies and governments sell to investors (like insurance companies) to raise money so they can operate. Bonds are a form of “IOU,” just like a bank loan. The organization issuing the bonds pays the insurance company that owns them interest, just like a borrower pays a loan from a bank. The more money an insurance company takes in from collecting premiums, the more money they have to lend and invest.
Mutual life insurance companies also invest in and own businesses that sell other profitable insurance lines, such as:
– Term life insurance
– Home and auto insurance
– Disability Insurance
– Group Health and Life Benefits
Mutual insurance companies also operate other profitable businesses (affiliate companies) such as:
– Mutual Funds
– Broker-Dealers and money management services to retail and institutional investors.
– Insurance Brokerages selling other company’s insurance products to earn commissions
Now you may be wondering,
“What in the world does all of this do for me if I own a whole life insurance policy issued by a mutual life insurance company?”
Here is the answer:
The owners of a mutual life insurance company are the owners of their whole life insurance contracts, so all the investment returns and profits these other business units generate goes to the whole life insurance policy owners through a “refund of premium.”
The more successful a mutual life insurance company is with its operations and investment strategies, the more premium will be returned to the policy owners. The amount returned over time can be significantly more than the policy owner ever paid into the policy too!
How do mutual life insurance companies return premiums to their whole life insurance policy owners? Through Dividends.
These dividends are like the dividends you might receive if you invest in a stock, but they aren’t exactly the same, and this is what makes them special, allowing for special tax treatment.
Mutual life insurance companies are not “for-profit” businesses. They exist solely to provide insurance benefits to their owners at the lowest possible cost. Therefore, the dividends paid to a whole-life policy owner are not considered taxable profit distributions like the dividends distributed made to the owners of a for-profit company. The dividends from whole life insurance are considered a return of the excess premium the company took in to provide those benefits and are returned income tax-free.
These dividends are not guaranteed. As the stock market disclaimer states, “past performance is no guarantee of future results.”
Still, I want you to know that most mutual life insurance companies have paid a dividend every year they have existed. Even during “The Great Depression” of the 1930s and “The Great Recession” of 2008-2009 because of their conservative approach to investing and underwriting that can weather the toughest financial storms.
Dividends from mutual life insurance companies are only paid if the mutual life insurance company has money left after they pay their business expenses (including the guaranteed interest) and insurance claims.
You need to understand all this because the dividends in a whole life contract are the main reason Infinite Banking and Bank on Yourself use whole life insurance as the base of their strategies. The concept depends on a policy owner borrowing money from their whole life insurance policy but the money still being available to earn any dividends the company declares.
It is absolutely 100% true that a whole life policy owner will receive dividends from the type of whole life insurance policy used by these two strategies…however, it isn’t as awesome as it is made out to be and you will not get rich because you are borrowing money from your policy. Instead, you are increasing your own risk without increasing your return potential by using the equity that is creditor protected and available for use without requiring credit approval.
Also, the interest you are charged for using this money reduces the potential total return of your whole life insurance policy. If you have the discipline or resources to fund a whole life insurance policy, there are likely cheaper ways for you to borrow money. I want you to understand paying interest to traditional lenders isn’t bad when it is cheaper and reduces your risk.
If you are a business owner, the loan from a traditional lender, like a bank, is likely tax deductible, further reducing your cost. The interest on money you borrow IS NOT tax deductible under any circumstances. The cash value accumulation in a policy is tax deferred though so you are losing tax benefits borrowing money against it by using after tax money to pay back tax deferred growth.
Too if you are in a bind after taking out a loan from a bank, you can borrow money from your life insurance contract as a last resort to keep you from defaulting. You can even walk away from a loan and choose not to pay it but still retain control of your money in your policy with its creditor protection.
I am writing this article on October 10th, 2022. A few weeks ago, we had a huge hurricane hit the Southeast coast of Florida.
Those who had their homes paid off are now at the whim of the insurance companies to get reimbursed. This may take 3 years! Those who had mortgages but had the equity of their houses in life insurance can let the bank deal with getting reimbursed while they can rebuild their life with the money they can access from their policy.
See how that works?
Money in life insurance should be used as a last resort when no other options are available.
You don't borrow money from your policy, you...
Here is what is really happening when you borrow against a whole life insurance policy. The life insurance company is making a loan to you using your policy’s cash value and death benefit as collateral to ensure they are paid back.
That loan to you becomes an asset in their investment portfolio and it is the safest, most profitable loan they can make. The insurance company is 100% in control over this money.
While a loan is outstanding, the insurance company is charging the policy owner interest, and there are (3) ways this loan will be paid back:
1) The policy owner can pay the principal and interest to the insurance company directly.
2) If the policy is surrendered, the insurance company will retain what they are owed before paying the balance to the policy owner
3) The principal and interest will be removed from the policy death benefit before the remaining balance is paid to the policy’s named beneficiaries.
In none of these three scenarios, are you creating money. You are incurring costs against your estate by borrowing against a cash value.
Life insurance companies create death benefits
The primary benefits of whole life insurance it’s guaranteed cash value growth and the death benefit. The dividends are a bonus and by themselves can help you build wealth. Borrowing the cash value doesn’t do anything to build wealth.
This doesn’t mean there isn’t some leverage to borrowing against a life insurance policy’s cash value.
As a policy owner builds cash value, their equity builds in the policy. When they take a loan against it, the policy’s death benefit is only reduced by the amount of the loan and not a percentage of the cash balance available. What do I mean?
Imagine you have a $1,000,000 whole life policy with a $250,000 cash value, and you borrow half of the cash value or $125,000.
Logically, you might think if you are taking half the cash value, then that would mean you would lose half the death benefit. So in this case, your death benefit is reduced from $1,000,000 to $500,000! This isn’t the case though.
Instead, if you were to borrow $125,000 of the $250,000 from this $1,000,000 policy, the death benefit would only be reduced by the amount of the loan, or $125,000. It would continue to be reduced by the interest being accumulated as a lien against the policy but by funding the policy, you create death benefit that wouldn’t have been possible had you not.
Therefore, the leverage the policy owner receives when they take a loan against a whole life insurance policy is the additional death benefit it provides.
Using non-qualified retirement income accounts as leverage
Here is another way to borrow money secured by assets that are more advantageous than borrowing against a life insurance cash value. Take out a margin loan against an investment portfolio.
If you own stocks, bonds, limited partnerships, TIPS, or Business Development Companies in a brokerage account, you can borrow funds against the equity in the account through a margin loan.
Just as there is with a loan against the cash value of a life insurance policy, there aren’t any underwriting requirements to access this money. All you have to do is set up the account, and the brokerage firm will allow you to take loans against it – no questions asked.
Also, just like a life insurance loan, there aren’t any payments due when you take a margin loan against an investment account either. You can even get a credit card to have that money immediately.
One argument that Bank on Yourself agents have for this loan strategy is that life insurance cash values don’t have the investment risk that an investment portfolio does. This is true. Life insurance is not an investment, and it is unique that it has the ability to increase in value without the worry of the cash value declining due to changing market conditions.
A fixed income portfolio can be created that reduces this risk significantly and can be reduced down to the risk in life insurance if CDs, treasuries, and even fixed annuities are used to construct the portfolio.
Like a life insurance company, the investment company places a lien on the portfolio to ensure repayment. The individual investments have the ability to grow in the account even with the loan against them.
At Decision Tree, our platform interest charge is low AND tax deductible against investment earnings. Our custodian puts a lien on your account to protect themselves so there is little risk. The margin rate at the time of my writing was 1.67%. That is much lower than a loan on a life insurance’s cash value, direct or non-direct recognition!
This interest is tax deductible too against investment earnings which further reduces the cost of borrowing to buy cars or take vacations.
The big thing is don’t spend more than you make. That is the simple rule of thumb to long-term financial success.
Conclusion on whole life with bank on yourself and infinite banking.
Whole Life Insurance does have its place. It just isn’t to have the ability to take loans against the policy regularly under the pretense that by borrowing, you are somehow creating wealth. This is just silly.
It is always best to use the cheapest money available when making a purchase. The cash value of whole life insurance could be the best asset to acquire the money you need, but it isn’t always the best option as the book “Bank On Yourself” suggests.
However, the fact that life insurance is contractually guaranteed to have a minimum rate or return as well as have the ability to earn dividends is an appealing attribute. In addition, whole life does have insurance benefits and long-term value that increases the longer it is held.
To be successful financially, an investor needs to be able to have someone who understands how to use all the financial tools that are available to make the best possible financial decision.
The primary benefit of whole life insurance is the death benefit and the policy’s ability to create a large pool of money at the death of a policy owner anytime the policy is in force. Whole life insurance does not expire as long as the policy premiums are paid.
It is wise to participate in a comprehensive planning process with a financial planner who understands how all the pieces of your financial life fit together. Investments, insurance, cash flow management, debts, taxes, retirement income sources, available benefits, and estate planning are all considered during the planning process.
If you are looking for the answers that make your life simple, save you time and put you in the best position to succeed financially, do yourself a favor and find someone you trust that can take you through the process and give you insight that will change your life.
There are many reasons to own a cash value policy like whole life insurance. Becoming your own bank just isn’t one of them.
