Can you really protect your loved ones with life insurance and buy some toys of your own?
The Short Version
Infinite Banking, and all its variants, is a financial strategy premised on the idea that you should set up your own “banking system” to finance things you want to buy. The concept is presented in full in a book called, Becoming Your Own Banker: Unlock the Infinite Banking Concept, by R. Nelson Nash. A competing book called, The Bank On Yourself Revolution: Fire Your Banker, Bypass Wall Street, and Take Control of Your Own Financial Future, by Pamela Yellen, promises to teach you an “enhanced” version of this concept.
This article assumes you have at least some familiarity with the ideas presented in these books. There are other (many other) books written on this topic, but these are the two big ones, and the source material everyone else uses to write their own book.
The basic idea behind it is that you finance everything you buy. You either pay interest to someone else or… you pay cash and lose the interest that cash could have earned. So, why not finance everything yourself and earn the interest you otherwise would pay to another lender? Assuming you agree with this premise, you start out by creating your own private “banking system,” of sorts, by saving up some money somewhere. Then, you use this pool of money to finance everything in your life. If you think about it, it makes a lot of sense. Regardless of what you do in life, whether you spend your money or you invest it, you have to use a banking system to facilitate the transaction. All of the money in the world goes through someone’s bank. Advocates of the banking concept argue that you should just set up your own “private bank” and use that instead of using someone else’s.
Furthermore, you only have two choices with your money — you can spend it or you can save it. There is no third option. If you spend it, logically you are not saving it. And, if you’re not saving it, then you’re not earning interest on this money. So, why not devise a system where you’re able to save more and more of your money by simultaneously reducing the amount of money you’re giving to banks, credit card companies, and other lenders? And, if you can still buy the things you were going to buy anyway, all the better.
The Long Version
I’ve gotten a lot of questions about this over the years, so I thought I would write a detailed article about it. It’s up to you to decide whether or not you think it makes sense for you. This is a long one, so lock the door and grab a drink.
Here. We. Go.
Using Dividend-Paying Whole Life Insurance
Nash, et al. often claim that “banking is a process, not a product.” You technically don’t need to use life insurance to pull this off, but most everyone you talk to will tell you it’s a good idea to use it. If you use a checking account, the process is dead-simple: build up a savings, “borrow” from yourself, repay yourself with the interest a bank or credit card company would charge you. You earn the interest a lender would have made off you.
So, why use a dividend-paying whole life insurance policy? Because… life insurance takes the basic idea and adds a guaranteed growth rate, (non-guaranteed) dividends, a death benefit, and attractive loan rates to the mix. It does add complexity, but it also adds the potential for more growth of your savings without introducing an unreasonable amount of risk. Whole life insurance is a guaranteed insurance product. The cash values are guaranteed to grow at a specific rate. The death benefit is guaranteed against loss. And, even though the “Infinite Banking” process involves taking out loans against your insurance policy, policy debt (as it’s called) does not resemble normal debt. Policy loans are secured against the cash value inside the policy, meaning the debt can be paid off at any time with existing policy values.
Because cash values are guaranteed, the risks inherent in traditional investing accounts don’t exist inside the whole life insurance policy. Some critics argue you could do better than using whole life. It’s possible that a speculative investment could earn more than a whole life insurance policy, but it’s a gamble (especially when you’re expected to borrow against your investments or cash them in when making the purchases you need to make). Introducing speculative investments increases the risk of this financial strategy, and it makes “Infinite Banking” more or less impractical for most people to pull off successfully.
The basic problem with using investments to do this is… it’s very easy to lose a lot of money because you introduce a lot of risk. You could be upside down on your loans, your savings could lose value, and moving in and out of investments creates a lot of transaction costs that you won’t have with an insurance policy.
Also, if you cash out of investments to “borrow” from yourself (instead of using loans), you lose interest on your savings until you fully repay yourself. This is why financial advisors often argue against taking loans from your 401(k) plan — retirement plan loans are not true loans. They are withdrawals from your retirement plan that you then repay with interest. The money does go back into your retirement plan, but you miss out on the growth in your investments in the meantime. This doesn’t happen with a life insurance policy, because the money never leaves the policy. The loan is a true loan.
Whole life insurance allows you to integrate insurance and a savings function (the cash value, which is not technically savings but rather equity in the contract). The cash value replaces the pure insurance over time and does it on a guaranteed basis. In a whole life policy, the death benefit is a combination of insurance and the cash value. As equity builds up in the policy as cash value, it decreases the amount of insurance in the contract. Eventually, the equity value equals the death benefit, and there is no more insurance.
Some life insurance companies take this one step further and offer potential for you to earn dividends on the policy which can grow the death benefit and cash value over time. Dividend payments are not guaranteed in advance, but… once earned, you can never lose the dividend payment or corresponding cash value. It becomes part of the guaranteed cash value.
In order to do this banking concept thing, you are going to need access to all of those cash values. You do this through the built-in policy loan feature of your contract. Policy loans are very different from traditional bank loans. First, there is no credit application and your loan is only limited by the amount of cash value you have available in the policy.
Secondly, there is no set repayment period. You choose the terms of the repayment. You may even keep the loan open until your death. If you do, the insurance company will simply deduct the loan amount from your death benefit and pay your beneficiaries the remainder. When you want to take out a policy loan, you simply call up the insurer and request a policy loan. The insurance company issues the loan, and then secures the loan amount with an equal amount of death benefit (some insurers say they secure the cash value) from your policy.
For example, if you have $100,000 in cash value in your policy, and you want a $10,000 loan, the insurer will give you $10,000 and then secure the loan with $10,000 from your policy. This leaves $90,000 available for future loans. As you repay the loan, your cash value is restored with each payment. What’s really special about these loans is that the insurer will continue to pay interest and dividends on the original $100,000 amount.
Some insurers change the dividend payout by lowering or raising it on any loaned cash value, while other insurers keep the dividend the same regardless of loan activity. You’ll hear the former referred to as “direct recognition” and the latter as “non-direct recognition.” This has been the source of much confusion for consumers, who often believe that a very specific type of loan needs to be set up on their policies for this to work. The reality is, both direct and non-direct recognition loans work well for this concept.
There’s no magic here.
With non-direct recognition, an insurer can afford to keep the dividend the same on loaned cash value because it either raises expenses in the policy or lowers the dividend they could otherwise pay to everyone, all the time (which slightly favors people who are taking loans all the time). It’s not a big deal, but something to be aware of.
With direct recognition, the insurer raises or lowers the dividend to reflect the fact that this money is no longer being invested by the insurer, but is instead out on loan. The policyholder’s interest payments, then, become a source of investment gain to the insurance company, which is then fed back into the dividend pool which is repaid to the policyholder at the end of the year when a dividend is declared.
It sounds like a lot of rigamarole, but it results in a very low-cost loan. In some cases, the loan rate can rise above the normal dividend rate, which encourages policyholders to borrow money from the insurance company and, in return, receive a higher dividend payment than they would receive without borrowing money.
Another reason policy loans are sought-after by policyholders is that insurance companies allow policyholders to repay the principal of the loan before paying interest during the year. Again, this helps reduce the cost of the loan and makes it a very attractive source of funds when and if you do need to borrow money.
How Nash, Yellen, and Others Do It
There are many advocates of the Infinite Banking Concept out there. R. Neslon Nash was the first. Others followed, like Pamela Yellen (“Bank on Yourself”), Don Blanton (“Circle of Wealth”), Jeffery Reeves (“You Be The Bank”), and Douglas Andrews (that “Missed Fortune” guy). Most advocates of the banking concept have argued, in the past, that you need to use a “life paid up at 65” policy or maybe a “life paid up at 100” or something similar. In order to build up the cash value quickly, you have to do something called “overfunding” the policy. This is done by adding a special rider to the policy called a “paid-up additions” rider.
The rider modifies the contract to allow additional premium payments to be made. The additional premium payments go directly towards buying paid-up life insurance death benefit which has its own cash value and generates its own dividend. There are no (or very small) commission payments paid to the agent on this additional insurance so the cash value for the additional paid-up insurance grows rather quickly.
Here’s a quick illustration of a $1 million Life Paid-Up At Age 100 whole life policy on a 40-year old male, standard risk rating, non-smoker:
And now, that same policy, modified to accept paid-up additions:
Premiums in this example, are payable to age 70.
A Life Paid-Up At Age 100 policy takes a long time to “mature”. Meaning, it takes a long time to build up $1 million of cash value in the policy — stretching the accumulation of cash value all the way out to age 121. That’s a long time to wait.
The custom whole life policy reaches $1 million in cash value by age 71 — much sooner. To do this, it requires modifying the $1 million policy to accept more premiums than would normally be required to maintain the insurance. The focus inside the policy shifts from slowly building up $1 million over a period of 81 years to rapidly building up cash value as quickly as possible (in this example, the target age for $1 million was age 70, though with enough premium, any age can theoretically be targeted for the target cash value accumulation).
Furthermore, because this is a dividend-paying whole life policy, dividends can add a significant amount of cash value and death benefit to the policy:
In this example, the $1 million savings goal is reached by age 60.
That’s the accumulation potential of whole life insurance all by itself.
What “Infinite Banking” does is add the potential to reach that $1 million goal even more quickly through the use of strategic borrowing and repaying of policy loans.
The problem with this process isn’t that it can’t be done. It absolutely can, and has been done for over a century. It’s that it’s complicated and difficult for the average insurance agent to follow. And, if it’s difficult for the average insurance agent to follow, it’s even harder for the average policyholder to implement successfully. There are some simple ways to set this up, but many agents overcomplicate the process, don’t have proper loan-tracking and management software, and don’t know how to properly set interest and repayment rates on policy loans.
The policyholder (you) doesn’t need to know a lot about policy design, but the agent sure as heck does. And, you need a very knowledgeable agent to help you.
Agents which are in short supply.
And even if an agent has heard of the concept, it doesn’t mean they will actually help you implement it. This financial strategy is very labor-intensive for the insurance agent and… it doesn’t pay as well as an “off the shelf” policy he can sell you. The combination of simplicity and low ongoing service requirements makes an ordinary Life Paid-Up At Age 100 a more attractive business proposition for most insurance agents. This is why you see most agents selling a “regular” whole life policy and not a “juiced up” policy designed for high cash value growth.
But, even if they want to help you implement it, it doesn’t mean they have the chops to pull it off.
“Overfunding” a policy requires an understanding of what a Modified Endowment Contract is, and how it can develop over time in response to various material changes to the policy, how to take policy loans and repay them with a paid-up additions rider on the policy, and monitoring how much money you’re paying towards the additional paid-up insurance rider when there is no loan outstanding so that the insurer doesn’t cancel the rider (most insurers will cancel the paid-up additions rider if you don’t use it after a certain period of time, though I’ve never heard an insurance agent adequately explain this to a client).
I have, however, personally seen agents butcher policy designs trying to set up one of these policies. It’s not pretty and the client won’t know until it’s too late.
Does this mean you shouldn’t ever buy a custom whole life policy? No, it does not. It just means you should make sure you’re working with a specialist. It’s like this… if you wanted a custom piece of wood furniture, you’d hire a master carpenter or a woodworking expert. You wouldn’t hire a weekend handyman or someone who does handyman jobs “on the side”, because he’ll butcher the job. No offense to handymen. But, if they aren’t also expert carpenters, they won’t produce the same results a master carpenter will.
Same thing here.
The world is full of averages. This is often the argument that’s made against using whole life insurance and, specifically, a concept like “Infinite Banking”. If an average agent probably can’t pull this off successfully, and the world is full of average agents, then… it’s probably not something you should try. Move on to something more “mainstream” and common. That’s sound advice if you want to be part of the mainstream and receive average advice that can be applied to a broad population.
In other words, if you don’t value specialists, then… don’t work with a life insurance specialist and don’t try to use “Infinite Banking” as part of your financial plan.
Side note: This is where I’ve gotten into some trouble with my fellow life insurance agents, and I’ve already taken some heat for it. While I do think using a custom whole life policy with paid-up additions produces the best results, it’s also not necessarily the simplest way to pull this off. When I originally wrote this piece, I neglected to emphasize this point. I want to do that now.
If you can’t find a knowledgeable, reputable, agent to help you out with this (and I cannot stress this point enough — the agent has to be very experienced in policy design), your second-best option is to use a 10-pay whole life policy.
That product will be guaranteed paid in full after 10 years. It builds cash value very quickly and you don’t have to worry about hitting that MEC guideline. There is a caveat here, and one that others have tried to call me out on, saying in essence: “If you listen to this guy… you’re limiting yourself as to how much money you can put into your policy. 10-pay life insurance doesn’t allow payments beyond 10 years and you can’t repay the policy loan with too much interest or it will MEC the policy.”
All true statements, but all of them irrelevant.
Look, I have not always been a great communicator, and I’ve made many mistakes in the past (like not properly emphasizing or clarifying a point I’m making), but I’m sticking to my guns on this one: if you don’t have an agent you can trust, do yourself a favor and use a simple product like the 10-pay policy. If you do have an agent you can trust, and he or she can prove they know what they’re doing, by all means use them and get yourself a custom policy. You’ll be much happier with it than a 10-pay whole life policy, I promise. I’ll address the alleged downsides of using a 10-pay in a moment.
Look at the illustration of a 10-pay policy below:
Your policy is paid up in full after 10 years with a 10-pay policy, and you don’t owe any more premiums. However, you don’t have to wait out the 10 years to start borrowing against it.
Let’s say you wanted to take out a loan in year 5 for $5,000. The 4th column from the left titled “annual loan Beg Year” shows you the loan amount you take in year 5. This figure is also duplicated 5 columns over under the column title “total outstanding loan end year.” The difference between the two columns is that one shows you the loan balance at the beginning of the year, while the other shows you the loan balance at the end of that year.
If you begin repaying the loan amount with a $100 per month suggested loan repayment, your loan can easily be repaid over the course of 5 years. The insurance company is charging 5% APR in this illustration. But, you can repay more than that (and it’s usually a good idea to do so for reasons which are outside the scope of this article). This $100/month loan repayment represents about a 7.5% interest rate on the loan. This would be like taking out a small loan for a used car with an APR of 7.5%.
Why do this?
One of the arguments against this concept is: “It’s stupid to pay interest on your own money.”
Well, no, it isn’t actually. Time has a value. This is why the banking industry exists. It has figured out what time is worth, expressed as an interest rate. Also, it’s really difficult not to pay interest on your own savings. For example, if you put $5,000 in your checking account and then go take out a loan for $5,000 (credit card, personal loan, mortgage, etc.)… you’re effectively paying interest on your own savings. The difference with the “Infinite Banking Concept” is you direct those interest payments to yourself instead of the credit card company.
Now… look at the restored cash value amount in year 10. When your loan balance is $0, this means that you’ve repaid the loan in full. In year 10, the “total outstanding loan end year” reads $0. The column just to the right of that, which reads “net cash value end of year” reads $30,431. Now, scroll up to the original illustration. There’s no loan being illustrated here, so you must look at the 8th column in from the left, titled “total cash value end year.” At year 10, you’ll see the cash value amount is $30,431.
Wait a minute. The cash value is the same for both policies.
This means the policy grew as though you had never taken out a loan at all. And it’s because money never came from the policy. It came from the insurer. Also, the insurer continued to pay the same dividend scale with the loan out against the policy. This is the effect of non-direct recognition. Again, not magic, but nice to know.
Many years ago, I used to oversimplify things by saying that the interest rate on the policy loan didn’t matter because it would all come back to you anyway. That was a mistake and one I’ve taken a lot of flack for. It’s not that it’s wholly untrue. It’s that I could have been more accurate in how I explained it.
Here’s what I mean: insurance policy loans are a very inexpensive way to finance things (most of the time). If you pay the insurer $1 in interest, and your dividend that year is $1, you’ve effectively recovered your interest cost. That doesn’t always happen, but it can. Now, if you pay $1 in interest to the insurer, and your dividend is $0.50 the next year and $0.50 the year after that, you still recovered your interest cost but it took longer.
Furthermore, a life insurance policy loan is the only loan I’m aware of where you can borrow money from a lender, and set up a repayment schedule to pay off the principal of the loan during the year before paying interest on the loan, thus reducing the total interest being paid to the insurance company over the life of the loan.
Is it possible to get a cheaper loan through a bank than though an insurer? Sure, anything is possible — it’s possible for a case of Jack Daniels to fall out of the sky and land on the roof of your house.
But seriously, a lot of it depends on what you give up by going to a bank and whether you’re really getting a better deal. Some insurance agents argue it’s all about the interest rate you’re paying. They’ll tell you if you can get a lower interest rate elsewhere, do it. And, while a lower rate is generally a good thing, the problem with that thinking is it’s not always obvious which is the better deal by comparing interest rates.
For example, here is how a typical life insurance policy loan schedule looks. This loan assumes a $5,000 loan paid back over 5 years at 5% APR:
It’s a little hard to see, I realize, but if you look very closely, you can see it shaves a small bit of interest off the loan and results in a true APR that’s actually less than 5%. Depending on whether you make the payment at the beginning or end of the month, this savings over a regular loan at 5% APR could be negligible. In this particular example, however, if you compared a loan from a bank at 5% and a life insurance policy loan at 5%, the insurance policy loan is going to come out slightly cheaper, in spite of the fact that both advertise a 5% APR.
Here is the same loan repaid at an 12% rate (again, sorry for the microscopic printout):
The loan principal is repaid in 50 months. If the policyholder carries out the payments to the full 5 years (60 months), roughly $1,440 will be added back into the policy’s cash value. You can click on the image to see a larger view of the payment schedule.
What this is saying is… if you normally qualify for a loan @ 12% APR (e.g. a commercial loan of some kind, a revolving line of credit, or a personal loan, or a margin loan or some other loan for investment purposes), then a policy loan is a lot less expensive than a conventional loan at the same rate. Not only are you paying less interest for the loan itself, money is being added directly to your policy at the end of the term (assuming you keep sending the insurance company money after the loan principal is repaid).
This is the effect of “The Banking Concept” at work — adding money back to your savings versus sending that $1,440 to another lender. By putting that money back into your savings, you benefit yourself, you have more money available in your cash value to borrow against in the future, and you have more financial security than you did before. And… that is an ongoing process that builds over time, accelerating the build-up of that $1 million goal.
Interest rates are very low right now for things like mortgages. But, credit card rates and personal loans still carry a high APR. Personal loan rates vary from 4% up to over 30%, but 12% is the average. Borrowing money to invest in other businesses or to invest “on margin” is expensive. Charles Schwab currently charges an introductory margin rate of 8.325% for debit balances up to $24,999.99. The lowest rate they offer is 6.575%. So, if you borrowed money against your life insurance policy to invest, you’d want to pay at least that much to mirror the market rate for this type of loan.
Keep in mind what I’m illustrating here is one loan. You can repeat this process an “infinite” number of types — hence the name. With a conventional loan, you have to requalify each time you want a loan, and you are not adding money to your savings or insurance policy cash value. You can also take on multiple policy loans at the same time from your insurance policy as long as there is cash value available.
At this point, I want to address the issue of the policy becoming a modified endowment contract (MEC) because I’ve been beaten up over this a lot by other insurance agents lamenting the use of an uncomplicated approach to IBC. If you’re going to use a 10-pay policy, make sure you have plenty of convertible term insurance waiting in the wings. Convertible term allows you to convert your term insurance to whole life. Why is this important? Precisely because you can only put so much premium into a 10-pay life insurance policy before it becomes a modified endowment policy. When your policy cannot accommodate any more premium, you’ll want to convert some term insurance to another whole life policy so you can keep your cool little system going. And, with convertible term, you don’t have to worry about health issues in the future limiting your ability to buy more insurance. The insurer must convert your policy to whole life, guaranteed.
If you trust the insurance agent you’re buying your policies from, have him or her design a “maximally funded” custom whole life policy which can accept unscheduled paid-up addition rider premiums in addition to scheduled paid-up additions rider premiums. These policies take some additional work to design because the policy must meet 2 conditions. First, the policy must be funded to IRS MEC limits with scheduled premium payments. Secondly, the policy must be designed such that you have the right to come back in the future and buy more insurance without additional underwriting being required and without the policy becoming a modified endowment contract.
As mentioned before, few agents know how to do this, and those that do may be reluctant to design a policy this way for you because of the additional work and ongoing customer service involved. For the record, I do design these policies all the time for clients, but I can only do so because I have excellent backend customer support helping me manage these policies. Without that support, I would not be able to offer this to clients.
Using a custom whole life insurance policy like this, fewer policies are needed, and you end up with more cash value over the long-term compared to buying a 10-pay or other limited-pay policy.
Here is an example of a 10-pay whole life and a custom whole life policy:
The 10-pay whole life policy is a $1 million whole life policy paid-up in 10 years. The custom whole life policy is the same one I showed you above.
The 10-pay policy is a $1 million policy, meaning the death benefit starts at $1 million, and the cash value will grow until it reaches $1 million. The custom whole life policy starts out at just under a million dollars of death benefit and grows to just under $2 million. The 10-pay whole life policy’s guaranteed cash value grows to $1 million by age 121. The custom whole life policy’s guaranteed cash value hits $1 million by age 71 — far more quickly than the 10-pay whole life.
This custom whole life policy makes extensive use of scheduled paid-up additions to rapidly grow the policy’s cash value, has a high guaranteed internal rate of return compared to a 10-pay whole life policy, and can accommodate more premiums through unscheduled paid-up additions rider payments without turning the policy into a modified endowment contract (thus protecting the policy from being reclassified by the IRS as an investment). With or without the unscheduled paid-up additions rider premiums, the custom whole life policy is funded up to the MEC limits based on the initial death benefit purchased (~$900,000).
And, that’s why I say a completely custom and comprehensive life insurance plan produces a better result. However, if you don’t know (or don’t trust) anyone in the insurance business, a 10-pay policy is the second-best way to go.
Either way, there really isn’t another financial product capable of pulling this off, which is why life insurance is the favored financial product for this concept.
And Now For The Problems…
Everyone who initially learns about this concept has the same reaction: “This is awesome! Why isn’t everyone doing this?” And then the skepticism sets in… “This sounds almost too good to be true. What’s the catch? There must be a catch.”
If you made it this far and the thoughts in your head matched what I just wrote above, congratulations. Your brain is functioning.
First of all, assuming you’re not a hopeless cynic, there’s a good reason to stop and think about what the potential downsides of a financial strategy are. You want to know the pros and the cons… not just the pros.
You also don’t want to know only the pros of one method, and the cons of another method. This is how cognitive bias forms and it makes clear thinking impossible.
And so, without further ado, here are a few cons of “The Banking Concept”, and the way it is commonly promoted, as I see it:
- The way it’s promoted makes it sound like some kind of magical thing that will solve all your money problems — it won’t. Granted, I think over the years, many promoters have toned down the sensationalism… but not all of them. And, I speak as someone who is very enthusiastic about the potential of whole life insurance. As written, there’s nothing inherently wrong with saving money and using that savings to purchase stuff you want to buy anyway. The problem is in how this concept is often promoted — the perception, whether real or imaginary — that you are somehow having your cake and eating it, too. Nothing is without cost, and that is true here. The policy loans do have an interest expense. Taking on policy loans incurs a cost. If you don’t pay the interest, and neglect your loans, there is a risk that your life insurance policy will collapse, and you’ll be left with no insurance. Furthermore, life insurance cash values are generally tax free, but only if you keep your policy in force. If you cancel your policy, you must pay income tax on all the gains in your policy. It’s like any other asset that you cash out for a profit. Thus, you must keep your policy in force forever, and if you want to avoid the policy collapsing, your agent must select a non-forfeiture option that includes a “reduced, paid-up” policy if policy loans put the policy at risk of lapsing.
- Historically, the marketing for this concept has been horrendous. A big part of “The Banking Concept” has always been about spending down your cash value to buy cars, computers, and a bunch of other consumable stuff. One, somewhat famous, promoter of this concept (and a New York Time’s best-selling author), used to use the tagline “Spend And Grow Wealthy”. They don’t use that tagline anymore, but they still promote the idea that people can get wealthy “just by financing their cars and vacations.” That’s how bad it is. Just to be clear, in case it’s not already abundantly clear, you cannot get wealthy by financing your cars and vacations or by buying any other depreciating consumer good. Yes, you can save a lot of money by running car loans through your life insurance policy, and you can force yourself to be more discriminating about the amount of debt you take on to make such purchases, but you can’t build wealth that way. You can only get wealthy by growing your income and savings, and by buying appreciating assets. Unfortunately, some (not all, but definitely some) promoters of “The Banking Concept” spend very little time discussing the value of just letting the cash values sit there and accumulate interest or… better yet, using the cash values to buy profitable investments outside the policy. The latter is an excellent form of risk control if done correctly, and a strategy many active investors use to protect their capital from being destroyed by an investment that turns against them. To be fair, there has been some significant improvements in the marketing on this front. But… instead of praising the inherently thrift-promoting nature of whole life insurance as an insurance policy, they are still obsessed with the idea of “becoming your own bank”, which leads to some very bizarre financial advice. It’s not that “The Banking Concept” doesn’t work as a way to cheaply finance things you want to buy. And, it’s not as though you can’t use it to help you stay motivated in growing your savings. Clearly, it works, as demonstrated above. And, it’s also true that — if you take into account opportunity cost — you do finance everything you buy. But, buying a whole life insurance policy is not the same thing as “being your own banker”. You are literally buying an insurance policy and… if you’re buying from a mutual life insurer, you are becoming part owner of that insurance company. You are not becoming part owner of a bank. Of course, the counterargument to that is that some experts now regard life insurance companies as “shadow banks”. But… I’m sorry. That’s all the time we have for today… tune in next week as we discuss etymology and the science of knowledge…
- Self-insurance, as explained in the original concept, is probably a bad idea for most people. Some original texts on this concept advocated people drop their automobile comprehensive and collision insurance coverage and “self-insure” through their whole life policy. For most people, this is a bad idea (especially if you’re buying new cars every 5 years or whatever). Even when you’re buying an older vehicle, there’s a certain amount of risk involved in retaining the risk of a collision or comprehensive insurance claim. A certain amount of your cash value has to be set aside and tracked specifically for this purpose, and strict risk management strategies have to be employed to make this work (just like a real insurance company) — something I’ve never seen “Banking Concept” promoters or insurance agents explain adequately (if at all).
- The institutions promoting “The Banking Concept” have become somewhat dogmatic about which insurance companies should be used (and which ones shouldn’t) and how policies should be designed for this purpose. Dogmatism is not good and usually ends up stunting discovery of new ideas that could upend old ideas, either improving the concept or potentially invalidating it in the future. Any legitimate financial strategy is falsifiable. In other words, it should be within the realm of possibility for a fact or set of facts to exist which could potentially make the concept invalid or outdated at some point. It doesn’t mean that such facts currently exist, but rather… could such facts potentially exist? Are there conditions under which the concept would not work or would not work as expected? If so, then you have a scientific theory worth investigating. If not, then you have a belief system, and you run the risk of being blind to any legitimate disadvantages, shortcomings, or nuances that don’t perfectly reflect the official narrative. I believe this has become a serious problem with the majority of promoters of this idea.
- It encourages people to approach whole life insurance with the wrong attitude — to not care at all about the death benefit, which has legitimate and enduring value (especially as you get older). And, even though some organizations have backpedaled on their stance concerning the death benefit of the policy, but this seems mostly lip service. In practice, the death benefit is still generally regarded as a nuisance by these folks, getting in the way of infinite policy loans. Even toward the end of Nelson Nash’s life, Nash said, in an interview, that the word “insurance” made “Infinite Banking” harder to understand and that, “it’s really a personal monetary system with a death benefit thrown in on the side just for the heck of it. That would classify it better.” I disagree wholeheartedly with this idea. Calling an insurance policy a “personal monetary system” hinders a person’s ability to understand how their whole life policy really works, not the other way around. And, that misunderstanding can eventually become very costly.
- There’s entirely too much focus on non-guaranteed, illustrated, growth rates on the cash value side. Whole life insurance is built on guarantees. The dividends enhance the policy’s cash values, but always by an unknown amount in the future. The farther off into the future you look, the more uncertain things look. For example, back in the 1960s, The Guardian Life Insurance Company of America projected a 30-year dividend rate of just 3% on its whole life policies. But, they were very wrong about their projections. Guardian consistently increased their dividend rate during the 1960s, 1970s, and 1980s, to peak at 13.25% in 1984, before slowing and gradually falling to 5.85% in 2018. This means, for 30 years, policyholders received much more than they were promised, and much more than the guaranteed rate in their policy. Likewise, the opposite has happened. When interest rates peaked in the early 1980s, many life insurers used double-digit projected rates on their whole life dividends, only to see them grind downward for the next 40 years. Now, we are at the bottom of a decades-long interest rate cycle. Where will dividend rates and scales go? I hope they go up, but no one can be 100% certain of that. The bottom line is, the guarantees are what power the contract. Are dividends significant? Yes, absolutely, but the exact future payment amounts are somewhat unpredictable, so I don’t sell a dividend rate as a hard and fast number you can rely on. At most, all I can tell you is what the company will pay you if things don’t change in the future. Insurance agents often criticize investment advisors (and rightly so) because they promote the inherently speculative nature of investment returns as hard facts that can be relied upon in financial planning and yet… they do something similar with non-guaranteed dividends. Why? See #4.
- Some versions of “The Banking Concept” advocate putting every last dollar you make into whole life insurance… just like — wait for it — it’s your own bank. That’s not only a very bad idea, it’s also something insurance companies will never, ever, let you do. It’s too risky for them, and it doesn’t make business sense for them to be that transactional in nature. With that said, it probably makes sense for most people to buy way more whole life insurance than they’re currently buying. There will eventually come a point when you are fully insured and, at that point, it’s time to “leave the nest” and find other good places to put your money. The amount of insurance you have, at that point, will be enough to protect you (by definition) from any catastrophic financial loss. Incidentally, you’ll have more than enough free cash available to make almost any investment you could ever want to make. The cash values you’ve built up in those whole life policies will also be enough to finance almost any major purchase you could imagine so you shouldn’t want for accessible savings. However, for most people starting out, quite a lot of money will go into a whole life insurance policy and that’s because… these folks are underinsured or worse… totally uninsured. So, while you wouldn’t want to put literally every dollar you make into life insurance, it might feel like that’s what you’re doing until you have a decent amount of life insurance in place.
- Just because it’s a mutual life insurer, doesn’t mean you should buy whole life insurance from them. Some mutual life insurers are awful. I won’t name names here, but I’ve seen some pretty awful policies being sold to the general public. Needless to say, the life insurance industry is a lot like every other industry in America. Most companies are average. A minority of companies are below average — the drek of the industry. These companies have terrible customer service. Their investment and portfolio managers are “meh”. Their policies technically do work as advertised, but… no one would describe them as “excellent”. Likewise, a minority are the cream of the crop. They almost seem like they operate in a different industry. The difference between a good whole life policy and a bad whole life policy is night and day. And, those are the companies you want to buy your whole life policy from — the cream of the crop. But, for some reason, I’ve seen a lot of the folks promoting “The Banking Concept” recommend very mediocre or average companies, and a few agents who sell policies from the really crappy companies. Another thing I see is the incessant promotion of indexed universal life instead of whole life insurance. If you want to know my exhaustive thoughts on this type of policy, I’ve written extensively about universal life insurance, and indexed UL in particular, here, here, here, here, here, and here.
- You have to commit to paying life insurance premiums, ideally for decades. And, positive returns on your cash value generally don’t materialize for at least 3-4 years, and sometimes for as long as 7 to 9 years. This is a very long-term financial strategy — a decades-long financial strategy. I don’t know why, but some folks can’t think that far ahead. And, for those folks, I recommend you stay away from whole life insurance. It’s only going to become and endless source of frustration for you.
- You have to keep track of your policy loans, or the whole thing falls apart. I’ve yet to see an insurance agent on the Internet explain how to keep track of policy loans very well. First of all, insurance policy loans don’t work like normal bank loans (see #2, this is not a bank). Principal is typically repaid during the year before interest. This requires a special amortization to be done if you’re going to make scheduled loan payments back to the insurance company and add more money back to your policy for future borrowing needs (which is highly recommended). Promoters of “The Banking Concept” don’t teach you how to amortize a life insurance policy loan correctly (when they do show you how to put together a loan repayment schedule, they treat it like a regular loan which is not how these loans work), how to add money to your policy during the loan repayment process, when to add it, or how to get the timing right so everything works like it’s supposed to. In other words, they are in love with the concept, but not the details.
With all that said, it’s easy to walk away from this article, after reading the “cons” thinking this is some sort of fringe thing. That nobody really puts a lot of money into whole life insurance.
The reality is… lots of people own whole life insurance. Over the past 5 decades or so, total policies in force have declined. However, more and more money continues to flow into whole life insurance. Today’s whole life policies tend to be larger policies, with larger cash value buildup inside of them.
People today tend to buy fewer whole life policies, but they buy larger policies, and those that do buy whole life insurance tend to view it as an asset rather than a liability.
Regardless of what you think about “The Banking Concept,” it’s something that has been used for well over 100 years in one form or another, and it will probably be used for at least another 100 years in one form or another. It has helped build some of America’s most iconic businesses, and… it continues to be a core financial strategy for some some half-million Americans today and counting. Collectively, there are many millions of people who own whole life insurance, but only a fraction of them are card-carrying “Banking Concept” folks.
With that said, it’s become quite popular over the years, and that popularity shows no signs of waning. In fact, if I had to guess, it will only become more popular in the future. I suspect that people will become more knowledgeable about its benefits and limitations, and that they will start to embrace the fact that they own a life insurance policy — which is inherently protective against financial risk — and not a “banking system.”
Right now, there is a bit more than half a trillion dollars sitting in whole life insurance policies at the major mutual life insurance companies. That doesn’t count the smaller mutual insurers and the stock companies selling other types of cash value life insurance. And, at least for whole life insurance, each year that dollar figure grows at a guaranteed rate. And, as people die, and death benefits are paid out, more insurance is bought, which pushes the dollar amounts even higher. The momentum at this point is, I believe, unstoppable.
People are waking up to the idea that stock markets are inherently risky, that maybe it’s not a great idea to put all of their savings at risk, and that they want some kind of certainty about their future — that they want whole life insurance to protect them. It’s not a strategy that everyone will find appealing. But, for some… it may be exactly what they need to feel secure about their own financial future.
* This article originally appeared on NuWire Investor. It was updated on Nov 30th, 2016 and again on June 19th 2020.