You’ve probably heard this term “Infinite Banking” all over the place. It is also known as the ‘Bank On Yourself” concept.
In theory it’s very appealing. Pay yourself interest instead of the bank The problem is that it takes CASH in order to loan yourself…CASH.
And here’s my issue with the Infinite Banking concept. A Universal or Whole Life Insurance policy is the basis for the operation to succeed. This means you need a significant amount of cash value in these policies for your to “bank on yourself.”
So, the next obvious question should be is how long does it take to get a significant amount of cash value in your life insurance policies?
Well, if you buy a policy through an insurance salesmen, it’s going to take some time. You probably won’t have much cash in the policy, if any, in the first 8 years or so.
However, even a firm like USAA or TIAA-CREF that sell their policies direct to the consumer they also have loads too, which reduce your cash value. Loads are synonymous with commissions. In fact, at USAA you pay a 5% load with each premium payment you make.
Now because there is no salesman commission you will see more cash value available to you in a shorter amount of time, but you probably won’t see much growth on that cash value for a few years until after the policy has been inforce.
Also, you need to know the difference between whole life and universal life insurance. Whole Life is literally there for your “whole life.” You just make the premium payments and when you die the policy pays out. Thus, the risk is on the insurance company.
Universal life (UL) means the risk is on you. There are a myriad different ways you can fund a UL policy. For cash strapped people mostly this means they’ll “under-fund” the policy with the idea of contributing heavily when they can more afford it. (For the record, I haven’t seen this happen).
On rare occasions you can overfund a UL policy too. This means you’re putting more in on the front end than the target premium allows. You can do that but there are restrictions on your ability then to “bank on yourself” because you have MEC’d the contract. MEC means Modified Endowment Contract and this will put limits on your ability to borrow against the policy and also poses a 10% withdrawal penalty if you take money out before you’re 59.5, like an IRA.
Lastly, with a UL policy, if there is not enough cash in the policy to keep it afloat it will lapse before you do and could potentially cause a significant tax hit, never mind the fact your insurance is gone too.
At the end of the day, I’ve RARELY seen ULs work as advertised. Doesn’t mean it can’t. It’s just a rare occurrence in my experience. If you are healthy, in your 40s or so, with excess cash flow, a UL may be a great option.
For everyone else, not so much.
Whole life isn’t a bad option because you know exactly what you’re getting for what price. The problem is though because the risk is on the insurance company and now you, you’ll get less life insurance coverage for each dollar of premium. This will make whole life a lot harder to work successfully in the infinite banking arena.