F.A.Q. #6 - Infinite Banking Explained
Updated: Feb 9
This concept has many different names - all a variation on a theme: "Infinite Banking", "Bank on Yourself", "Banker's Secret to Family Wealth", "Private Reserve Strategy", and many more. These concepts are sound, but often misrepresented.
Insurance companies compliance officers are often very leery of agents who promote these concepts because of how they are so often misrepresented. In fact, MassMutual (a very large insurance company) recently released a memo to their career agency field force regarding misrepresentations on these concepts. Today, we're going to go into depth as to how this REALLY works, and make it clear enough that even the compliance officers will be happy with it!
The premise is this: You finance everything you buy - you either give up interest on savings, or you PAY interest when you go into debt.
The promise of most of these "Infinite Banking" promoters is you can eliminate the loan interest and maximize your earnings. Is that possible? We'll explore that.
Let's start at the beginning:
How does borrowing from a life insurance policy work?
If you look at a life insurance policy on its own and how borrowing works, it doesn’t make sense for what these “IBC promoters” promise would happen.
For example: Let’s suppose you have $100,000 in your cash value life insurance policy earning 4%. Now, let’s assume you’d like to take out a life insurance policy loan for $50,000 to buy a used luxury SUV, and the loan interest charge is also 4%.
$100,000 x 4% = $4,000 in earnings.
$50,000 x 4% = $2,000 in loan interest.
If you do not pay the policy at least the minimum interest, then the interest is subtracted from the earnings:
$4,000 in earnings - $2,000 in loan interest = $2,000 net policy earnings.
However, if you DO pay the policy the minimum interest, then you restore the policy performance back to the policy:
$4,000 in earnings - $2,000 in loan interest + $2,000 out of pocket payment = $4,000 policy earnings.
Where are the "extra interest earnings" that "IBC promoters" are talking about? It isn't there! (Keep reading though!)
Note: Interest on life insurance loans are illustrated as charged for the full year in arrears (meaning up front). So when you take out your loan, the interest for the year is NOT charged immediately, but it will be illustrated as though it was. Like all loans, the interest will accrue throughout the year as a 'line item' on the policy. The interest can be paid each year out of pocket, or you can decide NOT to pay the interest out of pocket. While you have that option, I recommend being a good borrower of "your own bank" and paying the interest each year to keep the policy as healthy as possible.
Your advantage is, if you are shopping out your loan options, it's one of the least expensive ways to borrow AND it isn't using an "amortization" schedule where multiple years of loan interest is 'heaped' up front as multi-year loans do - such as auto or home loans.
Note 2: You will notice that I'm referring to a "non-direct recognition" type of life insurance policy. (That's an insurance technical term.) This means that the interest being credited is NOT reduced when there is a loan outstanding against the policy's cash values. You still get every dollar of interest that is the same whether or not there is a loan.
Conversely, a "direct recognition" policy DOES see that there's a loan against the policy's cash values and reduces the dividends and/or interest earnings accordingly by a certain amount of basis points - which differs from company to company. For my post purposes, I keep the discussion easy by talking about non-direct recognition and how it works. My explanations are more conservative so one can be pleasantly surprised if it is actually better than how I explained it here.
The “Infinite Banking” concept is a “Compared to what?” concept.
We now know how borrowing from a life insurance policy works. And yet, “Infinite banking” promoters talk about earning higher interest rates on borrowed money.
Well… not quite. You don’t necessarily EARN higher interest or higher dividends paid by the insurance company. You are SAVING and CONTRIBUTING that money yourself to yourself to continue to earn interest. Here’s the idea:
Let’s take the same example above for the used luxury SUV. Instead of borrowing from the life insurance policy, we take out an 8% car loan (a loan at market rates rather than a 0% promotion – more on that later).
$50,000 @ 8% market rate loan = $1,014 monthly payment OR $12,168 per year on a 5-year note.
Total first year interest payment: $3,693.83
You can do various car loan payments and compare amortization schedules here:
We already did the math earlier about borrowing from a life policy and the policy loan being 4% instead of 8%. Also, it’s an annual simple interest loan, rather than an amortized loan.
That means that with the life insurance policy loan, once you pay back the loan interest, every dollar on top of that… is restoring your principal back to the policy for future borrowing!
This is the power of collateralization - the ability to have your assets continue to work for you while you borrow against them for other purposes.
Now, it IS possible to have a POSITIVE ARBITRATION on these loans!
That means that it's possible for your policy to EARN more in interest than you pay on loan interest. However, for my purposes, I keep the rates the same to keep the numbers simple. I try not to count on that happening.
Lost Opportunity Cost
Many "Infinite Banking" books and articles promote that "you finance everything you buy - you either PAY interest to a lender, or you GIVE UP earning interest on your savings." And while that is true, the goal is to keep the interest charges as low as possible without giving up much (or any) interest earnings.
Life insurance policies are one of the most unique assets because you can do that - without margin calls on investment/brokerage accounts OR having to qualify for a bank secured loan (and bank spreads are almost robbery; you'd probably earn 1% on your savings and pay 15% on a secured loan!).
Why does the insurance company charge interest to borrow “your own money”?
Here's the blunt answer: They don't. You are not borrowing your money. You are borrowing the insurance company's money that is backed by your own asset: the life insurance policy. Your money continues to be in the policy. Here's my recent article on collateral: https://www.davidkinderfinancial.com/post/understanding-collateral-uses-for-credit-and-wealth It's just like the equity in your home. You can borrow against the equity in your home, but it takes a financial intermediary (like a bank) to help you borrow against your home so there is money to access. You then make payments according to the terms set in the home equity loan or line of credit agreement.
That's why I don't like these recent Lending Tree advertisements. They say "Don't borrow from the bank, borrow from your home (HELOC)!" The money has to come from somewhere and you have to make payments to someone. That entity... is a bank or other lending institution. They write you the check and you repay them according to the terms in the lending agreement.
The reason is because in each cash value life insurance policy, the insurance company makes certain profitability assumptions that they are required to fulfill (aside from dividends or index interest). Therefore, to make the policy perform as expected, they charge an interest rate. It actually isn’t “your money”. That money is securing the promised death benefit.
And yes, your beneficiaries get your cash value when you die. It’s a component of the total death benefit.
Here’s the formula:
Net death benefit = Cash Values + Amount At Risk – Any Outstanding Loans
Your beneficiaries DO get the cash values because it is a component of the total insurance death benefit.
Here is my article on that topic as well: https://www.davidkinderfinancial.com/post/2018/09/22/permanent-life-insurance-myth-1-debunked-the-life-insurance-company-keeps-my-cash-values
But David, what if I could get the same loan for 0%?
From an interest rate perspective… 0% beats anything else! I’d be a fool to recommend that you pay interest (to ANY source) when you can get 0%.
One consideration: As you build up your life insurance policy, I would NOT recommend buying a car for more than what you have in your policy.
Why? For “just in case”. Just in case you get laid off. Just in case you become disabled, can’t work, and can’t make your payments from your cash flow.
If you have an amount available in your life insurance policy to PAY OFF your car (or at least make your loan payments for a while), not only will you not have the risk of repossession, but you can preserve your credit standing while you’re looking for your next job! More and more employers do credit and background checks prior to offering or keeping an offer of employment to you. Why not give yourself every advantage possible? (Note: life insurance loans are NOT reportable to credit bureaus!)
Key Considerations to make “infinite banking” work for you:
1. You must only borrow what you would have responsibly borrowed in the first place. This doesn’t work if you’re spending money on things you really can’t afford, and the policy and payments just won’t keep up.
2. You must know the market rate and payment you would have to pay if you borrowed from another source. You can simply ask “If I were to finance this, what would be the interest rate, payment, and terms?” Make a note of it, but don’t accept. Borrow from yourself instead… if the rate you’d otherwise pay with them would be higher.
3. When you borrow from your life insurance policy, you must continue to make the same payments you would have made to another lender at their payments and interest rates. (This is being a good customer and borrower of “your bank”.)
4. If you run into cash flow difficulties, preserve your credit standing by using your "bank" reserves to pay off, or just make payments, to any other outside lenders so you can keep your credit in great shape.
You can do this with nearly any size policy, although the larger it is, the better it works!
That’s the “Infinite Banking” concept in a nutshell. It’s for responsible borrowers to make this really work, but it can be a great strategic asset and financial tool.
What kinds of life insurance policies can you do this with?
First, the older the policy is, the better it works. You can do this with participating whole life insurance policies and you can do it with Indexed Universal Life insurance policies. I do have a preference towards Whole Life Insurance policies for this concept. I used to be more in favor of IUL... however, with the most recent CSO mortality tables and insurance companies being required to use them and design their products to them, I find that IUL isn't as easy to design favorably for this concept. IUL companies have also been changing their index options to include "multipliers" (which I am NOT in favor of), and an increasing net amount at risk cost.
It could just be me, but with Whole Life insurance, you can have more cash values sooner on a guaranteed basis. It's simpler, and the simpler option, for me, is better for the client. In addition, for every 0% year for IUL, whole life insurance will have a gain. Long term, they even out for their performance.
The Downside (that almost no one talks about):
There is a big downside if you are NOT a responsible borrower. This could also be a reason why life insurance companies don’t promote this concept directly themselves – as they probably wouldn’t want to be “on the hook” for people misusing their policy values.
If your policy implodes (loans and interest exceeding the cash values in the policy)… you can have a “Phantom Income” tax of the amount of every loan on your policy added to your taxable income in the year the policy implodes.
What does that mean?
Let’s assume that instead of taking out a $50,000 loan against your $100,000 policy… you take out a $95,000 loan. (Just a rough example. You may be limited to borrowing up to 90% depending on the company and prevailing loan interest rates.)
The $95,000 loan at 4% interest = $3,800 interest cost
The $100,000 loan at 4% earnings = $4,000 policy earnings
You *might* be fine… but if you run into cash flow difficulties and you can’t make the interest payments?
You’d be one year away from adding that $95,000 to your taxable income in that year! In a year when you probably can least afford an unexpected additional tax burden by adding a 'phantom' $95,000 to your taxable income.
Here’s a Forbes article outlining more on what can happen.
Don't Bankrupt Your "Bank"!
My best advice: Use your policy! That’s what it’s there for! But stay in touch with your agent and review your policy status regularly - such as annually. Repay your loans back to yourself and make your policy as healthy as possible. If you have cash flow issues, pay what you can, but don’t forget about your policy!
How can this concept be misrepresented?
1. There is a misconception that you get to keep the interest paid to the insurance company and that it is directly paid to your policy. This is not true. The insurance company DOES charge interest against the remaining cash values for the interest rate applied to the remaining loan balance. But they are charging the interest first, and then you reimburse your policy to make it whole.
2. I saw an example using an analogy of "turning over inventory" more quickly and that enhances your policy (somehow). This may help outline how having flexible and unstructured loan sources can help you with a particular enterprise or endeavor, but it doesn't affect your policy. It is simply fueling your other ambitions, not enhancing your policy. Having liquidity, use, and control of your money is preferred to having your money locked away in government regulated plans for such ambitions, but it doesn't change your policy's performance.
3. Unrealistic expectations for the performance of the growth of your policy. Very recently, we've been talking about a TikTok'er who has been promoting the notion that his policy has a 30-year track record of paying over 15.3%. This is simply not true, even though the company has it in writing for a new index and using composite index performance to give a false notion of 'back tested performance'. I believe it to be misleading.
4. Not disclosing that it's primarily life insurance. As you can tell, I have discussed this at length. This is a life insurance policy, structured to be used for collateralization, but it is still life insurance. I'm not using any other term for it "like 770 or 702 account" or anything like that. I do like talking about this as a Life Insurance Wealth Contract (wealth meaning to build values in it, and contract since it is governed and regulated by federal and state laws), but it is obviously still life insurance.
It is a great concept. I only encourage that you work with someone who will help you properly manage your expectations and policy to help you get the most out of these strategies.