Whether it’s home mortgages, credit cards, student loans, or car loans, many people end up making massive interest payments to creditors throughout their lives. The interest paid diminishes wealth that could have otherwise gone into other investments.
Yet, if you invested in a particular type of insurance called a whole life insurance policy, it would be possible to fund these payments using the policy itself. This strategy allows an individual to take out a loan against the policy’s cash value and pay it back later instead of borrowing from a bank.
Whole life insurance policies always pay out so long as the premiums are paid. As such, a person can continue to borrow against their insurance policy many times as long as they are alive.
Fundamentally, this concept represents becoming your own bank. It is also known as infinite banking. The concept was popularized by the release of books on whole life insurance, such as Becoming your Own Banker by Nelson Nash. According to Nash, a person with enough money in whole life insurance policies can keep on borrowing from them-self using the policy as collateral.
In essence, you would be paying yourself by retaining the interest payment on the loans from your policy. This would allow you to enrich yourself or beneficiaries when the claim pays off in the event of your death. Also, you get to enjoy all the benefits of whole life insurance, which include:
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- A guaranteed tax-free payout for your beneficiaries in the event of your death.
- Cash value that will continue to grow at a guaranteed least crediting rate, with no risk of market loss.
- Tax-free growth and withdrawals.
- Tax-free loans.
- Annual dividend payments, as long as your carrier is a mutual insurance company owned by policyholders.
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How It Works
Rather than relying on the misconception that life insurance pays triple on business trips, a much better way to get the most value from your policy would be capitalizing on the concept of infinite banking.
At the heart of the infinite banking system lies two essential concepts that the policyholder should know of. These are mutually-owned life insurance companies and direct recognition — or the lack of it.
The concept of mutually-owned life insurance implies that the policyholders own the company instead of corporate shareholders. As such, the profits go to the policyholders in the form of tax-free dividends. This increases the returns in the policy’s cash value and reduces the cost of term life insurance.
An insurance company that practices direct recognition will pay dividends on the cash value remaining in a policy when a loan is taken out. In contrast, a company that does not practice direct recognition will charge interest on the loan taken out. But, it will continue paying dividends and crediting rates on the cash borrowed.
It is also important to recognize those insurance companies that do not practice direct recognition offer holders an arbitrage opportunity. This creates a very cheap source of credit.
This is achieved by taking the difference between the least crediting rate on cash values, plus dividend, and the interest rate charged on the loans. Say, for example, the dividend rate is 6 percent, and the interest rate is 5 percent. Your cost of capital would be 1 percent.
This system works because the cash value of the whole life policy continues to grow, earning interest and dividends even after taking a loan against it. Furthermore, the system requires an individual to continue putting in more money into the policy than they took out. This translates to a form of interest payment to yourself.
For instance, let’s say you wanted to finance car repairs that cost $15,000. You take a $15,000 loan from your whole life policy, and you set an interest rate that is higher than the interest charged on the loan from the insurance company.
The extra interest will be paid back to your policy’s cash value through the paid-up additions rider. As a result, the cash value in the policy will increase like it would in ordinary whole life insurance. The additional cash payment in the policy will create a larger cash value balance than invested had you not taken out the loan since you added more money into the policy.
Not Free Money
Contrary to what most people have been led to believe about infinite banking, the strategy does not give you the secret to generating limitless wealth.
Instead, the concept forces an individual to change their behavior and take a more disciplined approach when it comes to spending money. This is because you will have to commit to saving more money after making a significant buy.
Now, you may find yourself asking, is it wise to pay life insurance via your superannuation? The short answer is yes. Not only will this be cheaper since premiums are likely to be discounted and fewer health checks are required, but you will also be able to increase the amount on your cover, giving you access to more cash to borrow from.
In general, this strategy works best when the person banking on themselves has a robust cash flow. This is because whole life insurance policies cost roughly five to ten times as much as term insurance policies. Also, it could take a couple of years to build up the cash value in the policies which means that the individual has to be committed for the strategy to work.
A high yield environment is also necessary for infinite banking to work since most whole life insurance policies put their money in low-risk investments such as government and corporate bonds.
Cons Of Banking On Yourself With Life Insurance
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- As mentioned earlier, one of the downsides of infinite banking is the upfront cost; as well, monthly premiums are somewhat higher than regular policies. If you fail to make advance payments, the life insurance policy will keep the cash value upon your death, leaving the beneficiary to only receive the policy’s death benefit. And in case you do not pay back the loan, the amount will be deducted from the death benefit.
- It also requires a long-term commitment. This is not something you start for one year and decide not to do in the next. We are typically talking about a 10+ year plan, so if you are going to do this for a year or so, you will likely take a loss.
- It will also require a lot of discipline and some adjustment to your spending habits. The insurer will not set regularly scheduled payments on your behalf but will expect the loan to be repaid.
- For older individuals or those with pre-existing health conditions, qualifying for a new whole life insurance policy may be difficult. The amount invested in a permanent life insurance policy and the cash value could grow more over time in other investments like an index fund.
Pros of Banking on Yourself with Life Insurance
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- Tax benefits: The strategy offers a guaranteed death benefit that is tax free in addition to tax-deferred growth, tax-free policy loans and tax-free withdrawals. Typically, these benefits are not available with other loans.
- Liquidity: The cash value of the policy is liquid, so you can access it whenever needed, for any reason you see fit without the need of having to qualify to use the money.
- Dividends: If a mutual insurance company manages your policy, it likely pays dividends.
- Asset protection: Several states have regulations in place that protect money in life insurance policies. In short, the funds are shielded from the reach of creditors.
- Assured growth: Regardless of whether you borrow against the policy’s cash value, it will continue to accrue interest at the specified rate annually. And if the policy also pays dividends, you may be able to add a couple of percentage points to that growth rate.
- Equity: By putting your money into a life insurance policy, you get equity because the cash in the policy grows thanks to real compound interest. It is considered “real” because you never touch the actual principle when you borrow against it.
- Control: In contrast to other loan types, which require a borrower to use the money for a specific reason, you can use the loans you take out against your policy for any purpose, i.e. from business to personal needs.
Unlike conventional loans, policy loans do not need to be paid back; standard nonforfeiture law for life insurance applies in this case. So if you miss any premium payments on the loan taken out, you can still opt for a reduced coverage for the remaining term of the policy without future premiums.
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- Cash flow: In case an opportunity or an emergency arises, it is vital to have access to cash flow, which is precisely what infinite banking guarantees. Thanks to an easily accessible source of cash, you can react quickly and decisively when investment opportunities or emergencies come up.
- Most important of all, you can be your own bank with the ability to help others. Infinite banking also allows you to lend money to others and charge interest if you desire. This allows you to recoup the money you borrowed from your policy in addition to interest, making it an excellent strategy for building and sustaining wealth.
How to Set Up Your Own Bank with Life Insurance
Seniors without life insurance are in for a big surprise if they plan to depend on conventional retirement planning to deliver financial security. According to recent reports, pensions are nowhere close enough to fund basic living standards in retirement. This means individuals have to put other alternatives in place to guarantee a good quality of life after retirement.
Therefore, if the concept of being your own bank appeals to you, there are a couple of steps to consider before getting started. Here is a quick step-by-step guide on how to set up an infinite banking system using the whole life policy:
Start Young Because Premiums Will Be Lower
Similar to all life insurance products, premiums are usually lower when you are younger. And since your premium is locked in for the life of the whole life policy, it is much better to get in when you are younger.
Select a Reputable Insurer
Choosing a reputable insurer is of utmost importance since infinite banking is a lifelong process. You should therefore be able to rely on the insurance company for the long haul.
Go for a Non-Direct Recognition Policy
Whole life insurance policies pay you dividends on the amount invested. Some insurers may only pay dividends on the balance if you borrow from the policy. Choosing a non-direct policy recognition ensures the policy pays you dividends on the total amount you invested even after taking out a loan.
Insist on a Policy with a Cash Value Rider
What happens in most policies is that the life insurance company will retain the cash value upon the holder’s death. This means the beneficiary will only get the policy’s death benefit. Adding a rider on the policy that gives the beneficiary the cash and face value will ensure that you avoid losing the cash value built up over time.
Include a Paid-Up Addition Rider
By only paying your monthly premiums, it could take you a decade or more to build a significant cash value you can borrow against. Adding the paid-up-additional insurance rider to your policy will let you pay more into your cash value so you can grow it faster.
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