From time to time I get a question about the concept of using a whole life insurance policy to “bank”. This concept has been popularized under the trademarked terms “Infinite Banking®” (IB) and “Bank on Yourself®” (BOY) and prior to that, Lifetime Economic Acceleration Process® (LEAP). I usually refer readers/listeners back to an article I wrote about eight years ago called “A Twist on Whole Life Insurance“.
Honestly, very little has changed about all of this in the last eight years, so, if you are one of the 23 people (including my mother) who were reading this blog back then, you can skip the rest of this article. If this is the first time you have heard of this concept, then read on to get the unbiased truth about it. Today I’m going to cover the seven truths you need to know about “banking” with a whole life policy. But first, a quick explanation of what it is if you have not yet been exposed.
Definition of Infinite Banking/Bank on Yourself
The basic concept behind IB/BOY/LEAP is to get a bunch of cash value into a whole life policy and then, whenever you have a need for cash, you borrow that money against the policy cash value instead of borrowing it from a bank, withdrawing it from your bank account, or selling an investment. When you die, the death benefit is used to pay off the loans, with any remaining death benefit going to the policy beneficiaries (usually your heirs). Instead of having to go to the bank to get a loan, you can simply “borrow” the money from yourself. No matter what your credit score or the purpose of the loan, you can always get that loan from the policy at the terms set up when you bought the policy. Thus you are now “banking on yourself” instead of having to go to a bank. Okay, to be fair you’re really “banking with an insurance company” rather than “banking on yourself”, but that concept is not as easy to sell. Why the term “infinite” banking?
The idea is to have your money working in multiple places at once, rather than in a single place. It’s a bit like the idea of buying a house with cash, then borrowing against the house and putting the money to work in another investment. If you keep repeating this process “infinitely” you can have your money “working in multiple places at once”. Some people like to talk about the “velocity of money”, which basically means the same thing. In reality, you are just maximizing leverage, which works, but, of course, works both ways.
Frankly, all of these terms are scams, as you will see below. But that does not mean there is nothing worthwhile to this concept once you get past the marketing.
Let’s get into seven truths about IB/BOY/LEAP, so you can see through the cloud of half-truths and outright lies surrounding this concept to understand how it really works.
# 1 Infinite Banking Requires You to Buy a Whole Life Policy
Step one in IB/BOY/LEAP is to buy a whole life insurance policy. Whole life insurance has a terrible reputation, and for good reason. It is dramatically oversold. According to the Society of Actuaries, approximately 80% of policies sold are surrendered prior to death, which is an abysmal statistic considering it is a policy designed to be held your entire life. When I have polled doctors that have actually purchased whole life insurance, 75% of them regret purchasing the policy. The whole life insurance industry is plagued by overly expensive insurance, massive commissions, shady sales practices, low rates of return, and poorly educated clients and salespeople. But if you want to “Bank on Yourself”, you’re going to have to wade into this industry and actually buy whole life insurance. There is no substitute.
Be careful while you’re in there. Most agents will not sell you the right kind of whole life policy to do this properly. In fact, many of them will try to sell you something besides a whole life policy, usually some type of universal life policy such as variable universal life or index universal life. Bad idea. If you want to be an “Infinite Banker”, you need a whole life policy. The guarantees inherent in this product are critical to its function. You can borrow against most types of cash value life insurance, but you shouldn’t “bank” with them.
As you buy a whole life insurance policy to “bank” with, remember that this is a completely separate section of your financial plan from the life insurance section. You are not buying this policy in order to replace lost income in the event of your death. Buy a big fat term life insurance policy to do that. As you will see below, your “Infinite Banking” policy really is not going to reliably provide this important financial function.
Another problem with the fact that IB/BOY/LEAP relies, at its core, on a whole life policy is that it can make buying a policy problematic for many of those interested in doing so. If you have medical problems that make you more expensive (or impossible) to insure, this is not going to work well for you. Dangerous hobbies such as SCUBA diving, rock climbing, skydiving, or flying also do not mix well with life insurance products. The IB/BOY/LEAP advocates (salespeople?) have a workaround for you—buy the policy on someone else! That may work out fine, since the point of the policy is not the death benefit, but remember that buying a policy on minor children is more expensive than it should be since they are generally underwritten at a “standard” rate rather than a preferred one.
# 2 The Policy MUST Be Structured Correctly
Most whole life insurance policies are not structured properly to do “Infinite Banking”. Most policies are structured to do one of two things. Most commonly, policies are structured to maximize the commission to the agent selling it. Cynical? Yes. But it’s the truth. The commission on a whole life insurance policy is 50-110% of the first year’s premium. Sometimes policies are structured to maximize the death benefit for the premiums paid. This is also a bad thing for an IB/BOY/LEAP policy. The point of an IB/BOY/LEAP policy is NOT the death benefit. It’s to allow you to “bank”. So you do not want the policy structured for that purpose. There are three critical aspects of an ideally structured policy:
With an IB/BOY/LEAP policy, your goal is not to maximize the death benefit per dollar in premium paid. Your goal is to maximize the cash value per dollar in premium paid. The rate of return on the policy is very important. One of the best ways to maximize that factor is to get as much cash as possible into the policy. You want the ratio of premiums to death benefit to be as large as it is legally allowed to be without becoming a Modified Endowment Contract (which prevents the tax-free loans that are the point of the whole system). The best way to improve the rate of return of a policy is to have a relatively small “base policy”, and then put more cash into it with “paid-up additions”. Instead of asking “How little can I put in to get a certain death benefit?” the question becomes “How much can I legally put into the policy?” With more cash in the policy, there is more cash value left after the costs of the death benefit are paid. That leaves more cash for the dividend rate to be applied to each year. An additional benefit of a paid-up addition over a regular premium is that the commission rate is lower (like 3-4% instead of 50-110%) on paid-up additions than the base policy. The less you pay in commission, the higher your rate of return.
The rate of return on your cash value is still going to be negative for a while, like all cash value insurance policies. But instead of breaking even after the typical 10-15 years, using paid-up additions allows you to break even in as little as 3-5 years.
Non-Direct Recognition Loans
This concept is a little harder to wrap your mind around but is still absolutely critical to IB/BOY/LEAP. Some life insurance policies are “direct recognition” while others are “non-direct recognition”. These terms apply to loans against the policy.
Let’s say you have a policy with $200K in cash value in it and you decide to borrow $50K from the insurance company against the policy. Like all loans, this loan is tax-free. But it is not interest-free. In fact, it may cost as much as 8%. Most insurance companies only offer “direct recognition” loans. With a direct recognition loan, if you borrow out $50K, the dividend rate applied to the cash value each year only applies to the $150K left in the policy. Seems fair, right? Why should they pay you a dividend on money that is being used elsewhere? However, there are a few insurance companies that offer non-direct recognition loans on their policies. With a non-direct recognition loan, the company still pays the same dividend, whether you have “borrowed the money out” (technically against) the policy or not. Crazy, right? Why would they do that? Who knows? But they do. Often this feature is paired with some less beneficial aspect of the policy, such as a lower dividend rate than you might get from a policy with direct recognition loans.
While there are plenty of magicians in the insurance industry, there is no magic. The companies do not have a source of magic free money, so what they give in one place in the policy must be taken from another place. But if it is taken from a feature you care less about and put into a feature you care more about, that is a good thing for you.
Just because you maximize the paid-up additions and ensure the policy offers non-direct recognition loans, all is not yet hunky-dory. There is one more critical feature, usually called “wash loans”. While it is great to still have dividends paid on money you have taken out of the policy, you still have to pay interest on that loan. If the dividend rate is 4% and the loan is charging 8%, you’re not exactly coming out ahead. Some policies offer “wash loans”, usually starting after a few years.
With a wash loan, your loan interest rate is the same as the dividend rate on the policy. So while you are paying 5% interest on the loan, that interest is completely offset by the 5% dividend on the loan. So in that respect, it acts just like you withdrew the money from a bank account. There is no interest charged on withdrawals, but there is also not interest paid on that money once it is withdrawn. 5%-5% = 0%-0%. Same same. Thus, you are now “banking on yourself.”
Without all three of these factors, this policy simply is not going to work very well for IB/BOY/LEAP.
# 3 Most of Those Talking About This Concept Stand to Profit from It
The biggest issue with IB/BOY/LEAP is the people pushing it. Nearly all of them stand to profit from you buying into this concept. They may be selling seminars, books, or online courses, but most commonly they are simply selling whole life insurance, hoping to earn those fat commissions. In fact, there are many insurance agents talking about IB/BOY/LEAP as a feature of whole life who are not actually selling policies with the necessary features to do it! The problem is that those who know the concept best have a massive conflict of interest and generally inflate the benefits of the concept (and the underlying policy). They would have you believe it is a Secret Magic Pathway to Wealth, when in reality all it does is help you earn a bit more interest on your cash in the long run. The amount of hype in the books, courses, and websites is unbelievable and reflects significant misunderstandings even among many of its proponents.
# 4 It Allows You to Earn More on Your Cash in the Long Term
The real benefit of IB/BOY/LEAP is that you will probably earn a little more on your cash over the course of your life than you would in a bank account, at the cost of a few years of crummy returns on your money. Seriously, that’s it. You would never know it from all the hype. Proponents want you to compare borrowing from life insurance to borrowing from the bank. “Wouldn’t it be nice,” they say, “if you could always qualify for a loan to buy your next house, car, RV, or boat?” But that is the wrong comparison. You should not be comparing borrowing against your policy to borrowing from the bank. You should compare borrowing against your policy to withdrawing money from your savings account.
Go back to the beginning. When you have nothing. No money in the bank. No money in investments. No money in cash value life insurance. You are faced with a choice. You can put the money in the bank, you can invest it, or you can buy an IB/BOY/LEAP policy. Let’s see what happens when you want to get a boat 10 years from now with each of these options:
Money in Bank
You put a bunch of money in the bank. It grows as the account pays interest. You pay taxes on the interest each year. When it comes time to buy the boat, you withdraw the money and buy the boat. Then you can save some more money and put it back in the banking account to start to earn interest again.
Money in Investments
You invest a bunch of money. It grows over the years with capital gains, dividends, rents, etc. Some of that income is taxed as you go along. When it comes time to buy the boat, you sell the investment and pay taxes on your long term capital gains. Then you can save some more money and buy some more investments.
Money in IB/BOY/LEAP Policy
You buy a policy and stuff as much cash in it as it allows. The cash value not used to pay for insurance and commissions grows over the years at the dividend rate without tax drag. It starts out with negative returns, but hopefully by year 5 or so has broken even and is growing at the dividend rate. When you go to buy the boat, you borrow against the policy tax-free. Then you can save some more money and use it to pay the policy loan. As you pay it back, the money you paid back starts growing again at the dividend rate.
Those all work pretty similarly and you can compare the after-tax rates of return. The fourth option, however, works very differently.
Borrow for the Boat
You do not save any money nor buy any sort of investment for years. Then you want to buy the boat, so you go to the bank. They run your credit and give you a loan. You pay interest on the borrowed money to the bank until the loan is paid off. When it is paid off, you have a nearly worthless boat and no money.
As you can see, that is not anything like the first three options. It is nonsense to somehow equate any of the first three options to that fourth one. So IB/BOY/LEAP really is not about “banking on yourself”, it is simply a different way to invest your money. While it is an inferior way to invest your money for the first 5+ years, eventually it is a better way than just a bank savings account. It is nearly as liquid and safe and has higher long term returns. Of course, its returns are nowhere near what you should earn long term in an investment like stocks or real estate, even after-tax. So it is not going to be some magic pathway to wealth. But it will help you earn a little more on your cash long-term.
# 5 The Other Benefits
Of course, there are other benefits to any whole life insurance policy. For example, there is the death benefit. While you are trying to minimize the ratio of premium to death benefit, you cannot have a policy with zero death benefit. Nor can you “borrow out” the entire death benefit. So there will always be at least a little death benefit for your favorite heirs or charities. In addition, about half of the states provide significant asset protection to the cash value in life insurance policies. So in the (admittedly incredibly unlikely) event that you are successfully sued above policy limits and have to declare bankruptcy, you may get to keep any cash value you have not already borrowed out.
# 6 It Is Not Magic
Unfortunately, those are really the only benefits. Everything else is hype or even scam. IB/BOY/LEAP is not a magic pathway to wealth. In fact, it can even retard your wealth-building if it keeps you from investing in assets/investments with higher returns. If you are skipping 401(k) or Roth IRA contributions in order to fund this policy, you are almost surely coming out behind. This does not replace real estate investing; it is simply a way to save up to buy the real estate that will actually build your wealth. Some people selling these policies argue that you are not interrupting compound interest if you borrow from your policy rather than withdraw from your bank account. That is not the case. It interrupts it in exactly the same way. The money you borrow out earns nothing (at best—if you do not have a wash loan, it may even be costing you). If you are the type to keep a lot of cash around (perhaps while waiting to find your next real estate deal), this is simply a way to earn 3-5% instead of 1-2% on it, in the long run. That’s it. Not so sexy now is it?
# 7 It Is Not Revolutionary
A lot of the people that buy into this concept also buy into conspiracy theories about the world, its governments, and its banking system. IB/BOY/LEAP is positioned as a way to somehow avoid the world’s financial system as if the world’s largest insurance companies were not part of its financial system. Your money is still denominated in dollars, subject to inflation. It is invested in the general fund of the insurance company, which primarily invests in bonds such as US treasury bonds. No magic. No revolution. You get a little higher interest rate on your cash (after the first few years) and maybe some asset protection. That’s it. Like your investments, your life insurance should be boring. If it is making you excited and you feel a need to go proselyte it to your friends and family, you are likely mistakenly buying into the scammier aspects of the concept.
Infinite Banking/Bank on Yourself is not a scam, but the way it is sold frequently feels scammy. It is not a magic way to build wealth but may help you earn a little higher rate of return on your invested cash in the long run and provide a bit of asset protection you probably don’t need.
What do you think? Do you Bank on Yourself? Are you an Infinite Banker? What has your experience been like? Comment below!