Life Insurance is one of the single most important policies that Insurance For Texans can offer to you. I have had a front row seat to it's importance when my dad passed many years ago, and my mom had to make ends meet. Life Insurance is SO important that I carry multiple policies on myself. Life Insurance is also a powerful tool to transfer wealth because of some unique characteristics. It's also a complex tool because of the diverse offering of types of coverage along with optional benefits. Due to the diversity and complexity, it often used by some individuals in ways that you may not be able to dream up on your own. Permanent life insurance, which accrues a cash value, is often manipulated to create cash for other circumstances due to it's tax favored status. Some use it for retirement planning, some use it for estate planning, some use it for college planning of dependents, and others use it for regular bank like transactions such as lending. The last such use as your own personal bank is known as Infinite Banking.
What Exactly Is Infinite Banking?
Many wealthy people through time have used whole life insurance as a lynch pin of their portfolio of wealth. They saw it's ability to transfer estates tax free upon their passing along with the ability to shelter money inside the cash value fairly risk free. When the United States economy was in a mode of higher interest rates, the cash value of the policies would accumulate at phenomenal interests rates above five to seven percent. Rates we just don't see very often today quite frankly. As a result, these wealthy folks would use the permanent life insurance policies to accumulate wealth while also protecting their families future. When the cash value accumulated, the transfer of that inheritance could also transfer tax free in spite of the estate tax. It was, and still can be, a brilliant play.
Infinite Banking is a mechanism espoused by R Nelson Nash that took that initial idea a step further. He saw the cash value portion of Whole Life Insurance as a tool that could be leveraged for other purposes while the insured is still alive. Since whole life insurance is considered non-correlated asset that doesn't fluctuate with the market like other investment tools, the predictability of both the policy and cash accumulation is very advantageous. It has a 100% predictable pay out, assuming that you purchase that policy with a highly rated and stable company. As a result, Mr Nash espoused leveraging the cash value to fund activities through policy loans while the insured is alive and the cash value is continuing to accumulate.
Permanent Life Insurance's cash value has policy provisions where that value can be used in various ways. In Universal Life policies, you can actually use the cash value to pay premiums for you if you need. In both Whole Life and Universal Life, you will have provisions that will allow you to borrow against that cash value. The life insurance company does not care if you borrow the money to remodel your home, send you kids to college, or buy a new air conditioner. They are concerned with you repaying the money back plus the interest it would earn to make the accumulation of your policy remain predictable. There is no underwriting like there would be on a conventional loan. And as long as you are repaying the loan, no one bats an eyelash.
The folks espousing this theory, sell this concept to the policy holder as a massive benefit that can be accessed since the cash value is relatively liquid compared to hard assets like real estate. It also means that you are not dealing with a bank making a decision based on your credit worthiness. Oh, and you can pay yourself that interest instead to a bank. The idea is that it accumulates more wealth for the individual. And the wealth can then be leveraged in retirement using LIRP or in the passing of the estate when the time comes. This all sounds great! Where do I sign up?
But Is Infinite Banking All A Scam?
The big key here is that it's not necessarily a scam. But we must be careful because there are pitfalls to anything that you can put money into to generate a return on investment. Let's take a look at some pitfalls here.
- You need assets to be able to pull this concept off. This is not a $50 a month sort of deal unless you are starting this plan when you are five. Compound interest is awesome, but it has limitations. The cash value accumulation for most policies today is in the 3% to 5% range at best due to prevailing interest rates. That means that you are going to have dump cash into this policy early to have money to truly borrow against at some point.
- Taking loans against the cash value of your policy requires DISCIPLINE. If you don't pay off the policy loan, you lose all of the power of the mechanism. Not repaying the loan can result in a policy being converted to a reduced paid up status. That means you have a set face amount of life insurance that will pay out, but your ability to accumulate more cash value and subsequent loan activity is now gone. One thing we see in people over and over again is that they are not disciplined enough to actually get this one to the goal line.
- You are not diversifying your ability to accumulate additional returns. Fortunately, the cash value of life insurance doesn't see losses like a mutual fund assuming your payments stay on track. However, that predictability we mentioned earlier means that you cannot participate in the upsides of other markets or assets.
- Your assets are now locked up in a long term contract for the rest of your life. If you decide that the plan is not for you, there can be sizable tax penalties that can be incurred if you attempt to move your cash value to some product other than one that is insurance based like another life policy or annuity. That rigidity comes with a massive downside.
- When you buy life insurance, you are using a tool that is created for the specific purpose of mitigating risk. When you begin to use it for other things, you compromise it's ability to serve that purpose. Even though a hammer can get a screw into dry wall, it's not going to do it as well as a screwdriver no matter how much you want it to. The wall will have some deficiencies when you're doing it. We recommend using the correct tools for the correct jobs in all circumstances.
What Else Should I Consider?
In the end, if you feel like something is to good to be true, it probably is. We always tell people to stop and think why is this person providing me this concept, idea, or tool? Is it in their best interest or is it in mine? What do they have to gain by giving me this idea?
The term fiduciary standard is thrown around a lot in the world of financial services. It refers to always putting the best interest of you, the client ahead of everything else when a recommendation is made or advice is given. The reality is that the commission structures on a lot of these products are very large. And the assets being pumped into them are large as well. That makes for sizable paydays for the advisers. Ask yourself a few questions before you pull the trigger.
- Is this adviser only licensed to sell life insurance products, or can they advise me and provide access to other asset classes?
- Having multiple tools available means that they are evaluating multiple options.
- Is there a penalty that can be assessed to the adviser if they provide me terrible advice?
- A licensed FINRA representative can actually go to jail.
- Is the adviser requesting a majority of my assets or only a portion?
- Good advisers will encapsulate diversity in any portfolio of assets.
- Does this sound too good to be true?
- It's a bit cliche, but it's true. Think about it.
If you'd like a second opinion on investing or any of topics of this nature, reach out to us. We are not licensed to make those recommendations for you, but we know people who are highly trained and always put the best interest of you long before everything else that is on the table. Our goal at Insurance For Texans is to make sure that you mitigate risk in the best manner that you can accomplish it. And that means working with highly skilled advisers who can help you.
