A look at Infinite Banking, Becoming Your Own Banker, and cash value life insurance.
When trying to understand the Infinite Banking Concept* things can often get confusing to the point of giving up. Borrow money here, pay yourself back here, become the banker, and it goes on.
And, although these are valuable ideas, it can sometimes feel like dragging your feet through the mud.
What people want to know is: where is my money going and how does the underlying investment function?
So, we are going to tackle the essential core of the Infinite Banking Concept and how the underlying product, cash value life insurance, helps us improve on these three investment essential: growing money safely and competitively, reducing taxes, and having access to money.
But first let me go through a very, very quick explanation of the book “Becoming Your Own Banker,” the book that started all of this.
Nelson Nash’s “Becoming Your Own Banker – The Infinite Banking Concept”
This book is definitely worth reading (get your copy here). It focuses on being the banker yourself in your own financial life. Instead of putting money into an investment that you can’t control, the idea here is to put money into a life insurance policy. Then, when you need money for major expenses, you borrow it out at the life insurance company interest rate and pay yourself back at a higher interest rate to increase growth.
Already this may sound confusing.
The reality is this: “Becoming Your Own Banker” is a great concept and something everyone should study, especially if you are a business owner, real estate investor, etc.
But we can go on and on about borrowing and paying yourself back.
However, this isn’t solving the real problems individuals face.
Here are the two biggest major factors in almost everyone faces in their financial plan: Not saving enough money and losing money in the market.
Where many people ask: “How should I buy my car?” We ask: “Which car should I buy? How can I save more money?”
Where many people ask: “How can I earn more in my investments?” We ask: “How can I stop losing money in the market, pay less taxes, and still grow my wealth?”
By saving more money and stopping the holes in our financial portfolio we can have a much greater impact on our financial future compared to any other strategy.
And this is where high cash value whole life insurance comes into play–the underlying investment for the Infinite Banking Concept.
The Benefits of High Cash Value Whole Life Insurance
Even with R. Nelson Nash in the book “Becoming Your Own Banker,” whole life insurance wasn’t the goal.
The reason we focus so much on whole life insurance is because it fits so perfectly into what we are trying to accomplish.
Nelson Nash saw this too.
If there was a better place to put our money that would accomplish these same goals we would change the products we use tomorrow.
The reality is, as of right now, high cash value whole life insurance is the only investment that meets our three essential investment criteria.
That is: growing our money safely and competitively, lowering taxes, and having complete access to our money.
So, let’s look at exactly what high cash value life insurance is and why it fits these three criteria. We also want to be critical, so, after we go through the benefits, let’s look at the downsides and where this product restricts us.
#1 – Growing Money Safely and Competitively
Admittedly, our first criteria can be broken down into two different pieces. Even though high cash value life insurance accomplishes both of these—growth and safety—in the same way, we must look them individually.
Our number one rule is don’t lose money.
Without getting too deep into market research, etc. let’s just say losing money has a much greater impact on your financial portfolio than growth does.
This is what we call average vs. actual returns.
The reality is this.
If we have $100,000 in our investment account and we earn 50%.
We have earned $50,000.
And then we lose 50% on our money (now $150,000).
That means $75,000 in losses.
We end up with $75,000.
You can have the losses first or last it won’t matter. The fact is, when it comes to your investments, losing money has a much greater negative impact on your investments than growth ever will.
And to make matters worse, the “average” return on your investment is 0%.
So, we have an average growth of 0% but we lost 25% of our money.
This is the illusion of Wall-Street investing.
So, the lesson here is don’t lose money.
Whole life insurance solves this.
Whole life insurance has a guaranteed minimum growth. This means that, even if the company paid nothing in dividends, you would still have growth.
(And by the way, the companies we use have paid dividends for over 100 years—through the great depression and multiple recessions—which adds to the safety factor.)
So, when it comes to safety, whole life insurance meets our criteria for safe growth. But keeping money safe doesn’t sound flashy. People are more concerned about what they will earn.
The point of investing is to grow your money. Simple whole life insurance, as you probably know, isn’t a great place to grow money.
This is where the “high cash value” in high cash value whole life insurance comes in.
By structuring a whole life insurance policy differently, we can, in essence, load the policy up with cash.
Thus making it an investment.
By doing this we give the life insurance policy a higher cash value as well as increase the dividends we earn per dollar.
This is how we structure the policy to earn competitive growth.
When accounting for taxes saved, which we will do shortly, that growth becomes even more competitive.
And this policy wasn’t even a “high cash value” policy—it was just a standard 10-pay whole life insurance policy.
Through proper structuring, this policy could have likely earned even more.
This is what we mean by competitive growth. Sure, there is always a possibility that we can earn more in the stock market. However, there is also a possibility, and substantially more so, that ourselves, or our advisors, will often have losing years in the stock market.
Talking about funds trying to beat the market index, Warren Buffet said this:
“The bundle of hedge funds had compound annual returns of 2.2 percent in the nine years through 2016, compared with 7.1 percent for the index fund.”
The pros can’t beat the market, that’s how hard it is.
High cash value life insurance offers us competitive growth without the risk of market loss.
#2 – Lowering Taxes
When it comes to growing, and spending, money, taxes can have a major impact.
Not only is this a major impact on our financial portfolio when our money is growing, this can have an even greater impact when we retire.
Taxes and Growth
There are two ways to tax the growth on your money. Immediately—when you earn it—and deferred—when you take it out of your deferred account.
With life insurance we pay taxes on our money before we invest it, and then—if we plan correctly—we pay no taxes on the growth.
The question becomes: “Is deferring taxes better than paying taxes now.”
The reality is, deferring taxes is a roll of the dice.
Deferring is just postponing. So, there are some things we have to take into account.
The first is, retirement, which we will cover in just a second. But when we retire how much tax will we have to pay?
The second is tax rates, and this is where things become unclear.
Are taxes going to go up or down in the future?
Will tax brackets change in the future?
What tax bracket will I be in when I retire?
These are all very good questions, and probably hard to answer. However, the general opinion of almost everyone is that taxes will not go down.
This means, you will be lucky if taxes do not change from now until you retire.
There is a risk that taxes could go up before you retire. If this happens then you lose money because of that risk.
Sure, in a 401k situation there is a match we have to take into account. Saving up to the match can make sense for many individuals. However, beyond the match may not be a benefit.
If taxes go up, or tax brackets change, you may end up paying more tax than you expected.
By paying taxes now we eliminate these risks.
Taxes and Retirement
The second part of taxation is when you retire.
We have interviewed multiple accountants on this subject and the reality is this: almost no one is in a lower tax bracket when they retire than when they were working.
This means that, no matter what we originally thought about retirement, most people are retiring and paying more taxes than they originally planned.
Here are a few reasons.
- Children – After the kids grow up those deductions go away. Many of the deductions you had while you were working are no longer available to you. This means, more taxes.
- Home Mortgage – Similar to deductions for children, many are paying less, if any, home mortgage interest. This means even fewer tax deductions.
- Still making money – Many individuals assume when they retire they will stop making money. However, in today’s economy many individuals find they are still working in some fashion—this means more income and higher tax brackets.
Deferring taxes isn’t always a bad idea, however, know what you are getting yourself into. Cash value life insurance offers us a way to pay taxes now and then never pay on the growth.
And, as icing on the cake, when we use our life insurance cash value as income for retirement, we do not actually take it as income. This means that we reduce our actual retirement income which can reduce our taxes on earnings, taxes on social security, and potentially help reduce our tax bracket in a much more valuable way.
The last form of taxation comes when we die. With whole life insurance we get the benefit of having our money, in the form of life insurance death benefit, transferred to our heirs income tax free.
This is what we mean by deferring taxes indefinitely. With whole life insurance our money grows tax-deferred. However, when we die our life insurance death benefit (which has our cash value included in it) transfers income tax free.
This means that as long as our life insurance policy is not cancelled we will never pay income tax on any of the earnings in our account…ever.
We leave a legacy for our family in a safe and effective way.
#3 – Having Access to Our Money
The last investment characteristic we need is liquidity. Whether it’s for emergencies or opportunities, liquidity gives us control over our money when we want it—no matter what we want it for.
With 401k’s and IRA’s we are forced to lock our money away where we cannot access it. This can be a huge problem.
And because of this problem we are forced to have a side fund, like an emergency savings fund, that earns little to no interest.
These problems go hand in hand.
Government Sponsored Plans
401k’s and IRA’s are among the government sponsored plans where our money is locked away.
Here is a quick story.
When the 2008 crash happened one of my clients had decided to save money into his life insurance policy instead of in his 401k. Of course this was after careful study and understanding of what he was doing.
When the 2008 housing market came tumbling down, my client, had capital available in his policy that he could access anytime.
The housing crash was a horrible thing and many people suffered. However, he was able to take advantage of this situation responsibly and he purchased a few homes at rock bottom prices.
He has made a significant amount of money off of those investments.
You don’t have to be an investor. However, having liquidity, or access to your money, gives you the opportunity to do what you want when you want.
If my client had put his money in an IRA or 401k he may not have had the same options.
This same principle plays into emergency savings. If your emergency savings is locked into an IRA or 401k you may not be able to access that money.
On the other hand, if that money is in a bank account or money market account it will probably earn less that 1%.
Life insurance offers us a way to marry the two ideas. We can place our emergency savings somewhere safe and accessible, while still having the growth potential of an investment vehicle.
This makes life insurance a very smart place to put our emergency savings fund.
The point is, having access to your money is a massive benefit that gives you the options to do what you want today, while also giving you the freedom for whatever may come your way tomorrow.
The Downside of High Cash Value Life Insurance
No investment product is perfect.
Although the benefits of high cash value life insurance massively outweigh the downsides, there are downsides.
These downsides don’t make life insurance unusable, they do, however, force us to be more planned in our approach.
#1 MEC – The MEC, or modified endowment contract, is a regulation that tells us how much money we can put into a life insurance policy. Because of this, we must buy death benefit. Although death benefit, especially in retirement, is a must have, buying it up-front can take our money longer to grow. This means that some of our money, although it will be recouped later, goes towards death benefit costs that we may or may not need immediately.
#2 Five Year “Sweet Spot” – Because of the MEC and the death benefit, life insurance takes a few years to catch up to itself. This does not drastically impact long-term growth. However, because some of our money is going to base death benefit, it can take a few years for us to see the actual returns on our money. This forces life insurance to be a much more long-term strategy instead of something we can buy and sell as we please.
#3 – Dollar Limitations – Although we can put as much money into life insurance as we want, each life insurance policy will have a dollar amount specified when we start it. This means that, if we decide to invest $1,000 dollars a month into a life insurance policy, our maximum amount we can put into our policy is $1,000. To make matters even a little more complicated, our limit, in this case $1,000 dollars, is also our most efficient dollar amount. So, by maxing out our life insurance policy we will get the most benefit possible. Especially in the first five years.
There is No One Size Fits All
What R. Nelson Nash started was a unique new perspective on whole life insurance and how to maximize the safety, tax advantages, and liquidity that can be found inside of this investment vehicle.
Whether you call it Infinite Banking or by another name there are many different methods for doing the same thing.
What we do want to emphasize is that Infinite Banking and other life insurance investments that work do not involve or utilize universal life insurance in any way. Universal life insurance is much different than whole life insurance and there are some fundamental flaws that make universal life not only risky, but very expensive.
Infinite Banking and whole life insurance offer a very strong and practical option for investing. However, in the end it will greatly depend on your own personal situation, risk tolerance levels, and financial goals.
There is no one size fits all with investing.
Every investment has its downsides. Where one may see a safe investment that has competitive gain another may see a weak investment that doesn’t offer any risk.
Each individual is different. Find the right investment for you and stick to a long-term plan.