Most personal finance concepts are extremely simple. They only seem scary and complicated before you spend a few minutes chatting with someone who can explain them in lay terms.
Then there’s the infinite banking concept, or IBC to the initiated. The word “simple” doesn’t come to mind.
Still, for wealthier individuals, infinite banking offers some intriguing benefits. Consider the following a high-level overview to introduce the IBC, to help you decide whether you want to speak further with an expert about it.
What Is the Infinite Banking Concept?
At its core, infinite banking is about becoming your own bank, rather than saving or borrowing money with a traditional bank.
You do that by opening a whole life insurance policy (more on that shortly), then using that as a tax-friendly vehicle for holding money. As the cash value of your policy rises, you can tap into it at any time by borrowing money.
Because the loan is secured by your death benefit, you can borrow at low interest rates. Better yet, your policy can continue earning interest and dividends, despite you having borrowed against it.
Although life insurance has been around since the ancient Romans, and people have been using it creatively for centuries, the infinite banking concept was popularized in the mid-2000s by R. Nelson Nash’s book “Becoming Your Own Banker.” If “popularized” is a word you can use to describe a niche financial movement among the wealthy, that is.
In short, infinite banking offers another take on how to store money to access later. It comes with many unique advantages, along with some pretty steep disadvantages.
The Role of Whole Life Insurance
Before going any further, it’s worth pausing to note that there are two main types of life insurance: whole and term life insurance.
The simpler of the two, term life insurance offers temporary coverage to pay your family if you die prematurely. You pay the monthly premium, you get the coverage, until you discontinue your policy.
By contrast, whole life insurance stays with you for the rest of your life. It comes with a far higher monthly premium, but it also carries a cash value that builds over time, in addition to the death benefit. You can withdraw that cash value, or borrow against it at advantageous interest rates.
For infinite banking, you want a dividend-paying whole life insurance policy from a mutual insurance company. Mutual insurance companies are owned directly by policyholders, whereas stock life insurance companies are owned by outside shareholders.
Unfortunately, whole life insurance gets extremely complicated, and quickly. There are near-endless permutations for different types of policies and how to structure them. And since neither you nor I are experts on whole life insurance, we end up having to rely on outside experts — who are all trying to sell us something.
Complexity is a recurring theme, even as you explore the perks of infinite banking.
Pros of Infinite Banking
Why would anyone jump through the hoops necessary to become their own bank?
It turns out there are some compelling advantages to the IBC, even if many prove more useful to higher net worth individuals than to the average Joe.
If you structure your whole life insurance policy correctly, you can avoid paying taxes on both your contributions and withdrawals.
That means simultaneously getting the tax benefits of both a traditional and a Roth IRA, in a single asset. I only know of one tax-advantaged account that offers similar tax benefits, and that’s the health savings account (HSA).
The cash value of your insurance policy grows from interest and dividends each year, tax-free. You don’t pay taxes on the money if you borrow against it. In some cases, you don’t even pay taxes on it if you take a distribution.
When you die, your children or other beneficiaries don’t pay income taxes on the death benefit. They only pay federal estate taxes on it if your total estate exceeds the estate tax exemption ($11.7 million in 2021). Even if your estate exceeds that figure, you may still be able to help your heirs avoid estate taxes with an Irrevocable Life Insurance Trust.
Don’t try creating one of those at home. Like every other concept relating to infinite banking, you should get expert help from a financial professional before proceeding.
Guaranteed Return on Investment
Unlike stocks, whole life benefits don’t come with any volatility. You agree on terms up front with the insurance company: what you’ll pay each month, how quickly your cash value grows, and the death benefit paid to your heirs. No surprises, no plot twists, just a contract between you and them.
Technically, you run the risk that the insurance company becomes insolvent. But the U.S. places some pretty sturdy guardrails to protect consumers against that risk, including state-run insurance guaranty associations and mandatory reinsurance among providers.
Because you can borrow against your cash value at any time, quickly and without a loan application or credit check, you have similar liquidity as a savings account or money market account.
That means your whole life policy can double as your emergency fund. In turn, it means potentially earning higher returns with better tax advantages than a regular bank account. Which says nothing of the other purposes your whole life policy serves, such as the death benefit.
That said, not all whole life policies allow you to borrow against the cash value right away. Again, you have to structure your policy with precision, which probably requires an expert’s help.
Continued Interest and Dividends Even for Loans
When you borrow money against your life insurance policy, you keep earning interest and dividends on the full amount.
That’s because technically, you didn’t pull any money out of your policy. You borrowed money from the life insurance company, and your balance is simply the collateral. So it keeps earning cash flow.
That takes the sting out of borrowing money and paying interest on the loan. For example, if you earn 3% in interest and dividends on your policy, and you borrow money at 5%, you pay an effective interest rate on the loan of only 2%.
Compare that to taking out a car loan at 5%, or a personal loan at 10%, or a credit card balance at 20%.
Flexible Retirement Savings
While whole life insurance is not an investment and doesn’t generate returns comparable to stocks or real estate, it does offer a savings vehicle with greater returns than a savings or money market account. After decades of tax-free compounding, your cash value can provide a deep well to draw on.
And because you can withdraw it as cash, risk-free, it can help you manage and avoid sequence of returns risk early in your retirement. If the stock market crashes, you can wait it out while taking distributions or loans from your policy.
It’s so flexible, in fact, that you never have to pay it back. It simply reduces the death benefit that your heirs receive upon your death if you don’t.
As a general rule, creditors can’t seize your whole life insurance policy. They can’t force you to surrender it or borrow against it. That goes for bankruptcy proceedings in most states as well.
If you die and the policy pays out your death benefit to your estate — rather than directly to your heirs — creditors could access it.
But asset protection gets complicated quickly, so speak with an attorney before incorporating whole life insurance into your asset protection strategy.
Sheltered from College Financial Aid Applications
On the Free Application for Federal Student Aid (FAFSA), parents do not need to report the cash value of their life insurance policies. That works out quite well for parents planning to borrow money against them to help with their kids’ tuition.
In contrast, parents do need to disclose 529 college savings plans on the FAFSA, and they do impact your child’s financial aid. The same goes for Coverdell education savings accounts (ESAs).
Some parents use infinite banking as a college savings vehicle, and after repaying the balance back into their life insurance policy, they can turn around and draw it down in retirement if needed.
Possible Divorce Protection
One area where the complexity of whole life insurance can help you is in divorce proceedings.
Your divorce court and your ex-spouse’s attorney may or may not push for classifying your whole life policy’s cash value as a “marital asset” when divvying them up. You can make a case that the policy helps your ex-spouse and your children, not you, because they’re the beneficiaries.
In fact, some divorce courts explicitly order the higher-earning ex-spouse to go out and buy life insurance. You can preemptively structure it to offer you benefits as well, in the form of infinite banking.
Bear in mind too that the cash value of your whole life policy only grows impressively after many years of paying into it. While ordinarily a disadvantage (discussed further below), in divorce proceedings it helps you. The policy looks unassuming and unimpressive in the early years, before the cash value catches up with the monthly premiums you’ve paid into it.
Still, don’t go through all the hassle of implementing the IBC solely as a hedge against divorce. Besides being insincere to the point of cynicism, the strategy is far from guaranteed, and could backfire on you if the court orders you to surrender the policy entirely.
Estate Planning and the Death Benefit
In addition to all the advantages outlined above, your kids or other heirs also get a huge tax-free payout upon your death.
That makes it an estate planning tool in addition to a banking, lending, tax protection, asset protection, and retirement savings tool. Which to me makes the best case for infinite banking: it serves so many different purposes at once.
Even as you build a flexible asset with many protections, you also leave a legacy behind for your children. And that says nothing of managing the risk that you die prematurely by making sure your loved ones don’t suffer financially. That is, after all, the primary reason most people buy life insurance!
Cons of Infinite Banking
I’ve already touched on several of them, but for all those advantages, there are plenty of reasons to cast a wary eye on the IBC.
Complexity and the Need for Third-Party Consultants
I’m a huge believer in simplifying and automating your savings and personal finances. But there’s nothing simple about the infinite banking concept.
I scheduled a call with Wealth Without Wall Street, a consulting firm that helps people structure their life insurance policy for infinite banking. I knew them from appearing as a guest on their podcast a few years ago, and know them to be experts in this field. I figured a consultation call would be enough to ask seemingly basic questions like “How do you ensure your premiums and withdrawals both stay tax-free?”
By the end, I had more questions than answers. And while I recognize that I was speaking with a sales rep, I entirely believed him when he said, “You really need an expert’s help to structure this properly.”
Which explains why an entire consulting industry has risen up to help people set up infinite banking. To their credit, Wealth Without Wall Street told me that if I just want help structuring the policy for infinite banking, they can do that for free. They earn money through a high-end subscription package that includes a series of one-on-one calls, weekly live Q&A sessions with experts, a community for peer support, and access to a range of tools and calculators.
Don’t expect an insurance agent to understand the first thing about IBC however. To get it right, you need to speak with an expert consultant, who may or may not charge you for their service.
High Monthly Commitment
Whole life insurance is expensive. Think hundreds or thousands of dollars per month.
On the one hand, you can think of it as forced savings, automated for you. But it can become burdensome if you lose your job, change careers, or retire early.
Note that you can front-load your premiums to pay them in the early years of your policy, rather than spreading them out for decades to come. But again, you need to know what you’re doing when you structure your policy.
Lengthy Surrender Period
In most cases, you can’t close or “surrender” your whole life insurance policy for at least five to 10 years from opening it. That makes it a rather long-term commitment with little flexibility if your goals or circumstances change.
More accurately, you can surrender it early. But the insurance company hits you with hefty fees and penalties, and you begin to understand why they use the term “surrender” when referring to closing your policy early.
Long Delay for Your Cash Value to Catch Up to Payments
When you first open a whole life insurance policy, its cash value is lower than the amount you’ve paid into the policy to date. And it stays that way for years, often decades.
Five years into a policy, for example, you might have paid $50,000 into it, but only have a cash value of $20,000. So for banking purposes, you can only access a fraction of the money you’ve set aside through your policy.
Proponents of infinite banking would fire back that, once again, you can structure your policy in a way that gives you access to your money quickly. But that might require you to pay their consulting fee in order to get it exactly right for you.
Eventually, your cash value exceeds the money you’ve paid into the policy, as the interest and dividends and tax savings all do their part to ramp it up. But “eventually” could be measured in decades from now if you don’t structure your policy correctly.
Tax Risk of Funding Too Quickly
After reading about that delay, you might feel the temptation to simply load a bunch of money into your policy quickly. But if you do it incorrectly, you cross the IRS threshold for a modified endowment contract (MEC) and suddenly you lose the tax perks of infinite banking with a whole life policy.
Again, consultants can show you how to avoid this risk — after you pay their fee.
You Have to Qualify Medically
Life insurance companies price their policies in part based on your health. Which means they want to see medical exams before confirming a quote.
In turn, that means that the value and potential savings of infinite banking partially depends on your health, age, and other factors that don’t typically affect banking. The less healthy you are, the less advantage you can expect to find in infinite banking.
And that says nothing of the inconvenience of getting a battery of medical tests.
Who Should Consider Infinite Banking?
To listen to consultants explain it, everyone and their mother should “become their own banker” and “escape the tyranny of banks.”
But in an age of free checking, commission-free brokerages, and free robo-advisors, I have to disagree.
The average person doesn’t need acrobatic financial maneuvers and a level of complexity so opaque that you effectively can’t set up your own banking without help. Quite the opposite — the average person needs simplicity and transparency in their personal finances.
Of course, not everyone’s finances are average. The wealthier you are, the more attractive features like asset protection, tax protection, sheltering funds from college aid, and advanced estate planning become. And the more appetite (and money) you likely have for advanced strategies like infinite banking.
Given the delays involved in seeing returns on your efforts, infinite banking works better for relatively young, successful people. The older you are, the less time you have for the policy’s cash value to surpass your total investment and start yielding true returns.
At its best, the infinite banking concept helps your money work for you in many ways simultaneously.
But unlike the rest of your personal finances, you truly need outside expertise to get infinite banking right.
Only you know whether the complexity of setting up infinite banking is worth the benefits. Consider it an advanced financial strategy best suited for relatively wealthy, savvy, young-ish Americans.