The infinite banking concept is an approach to personal finance that involves buying a whole life insurance policy and using it as collateral for loans. In this way, someone utilizing the infinite banking concept can “become their own bank” and not rely on banks for their financing needs.
The infinite banking approach was pioneered by Nelson Nash, a financial advisor who adhered to the Austrian school of economics. Nash explained the concept in a book titled Becoming Your Own Banker: The Infinite Banking Concept.
What is infinite banking?
The infinite banking concept revolves around taking out a whole life insurance policy, and then taking out policy loans when required. The funds you receive from policy loans are tax-free, although you do have to make a simple interest payment on the money you borrow this way. Essentially, the infinite banking personal finance strategy uses life insurance as a source of liquidty.
Now, let’s quickly explain the most important concepts that are involved in the infinite banking strategy.
Whole life insurance
Whole life insurance is a type of life insurance that is permanent and gradually accrues a cash value.
Of course, a whole life insurance policy provides a death benefit to its beneficiaries in the event the policyholder dies. However, whole life insurance also has a savings component called the “cash value”, which can be accessed by the policyholder while they are still alive. Every time a premium payment is made, part of it goes to the cash value. This cash value grows at a rate fixed by the insurer, typically at a rate of between 1% and 3.5% per year.
The cash value of an active whole life insurance policy can be used as collateral to borrow money against.
Policy loan
A policy loan is a loan that is issued by an insurance company, and utilizes a life insurance policy’s cash value as the collateral. Sometimes, policy loans are referred to as life insurance loans. Policy loans tend to have lower interest rates than personal loans, and the borrowed funds can be utilized in any way the borrower sees fit.
A policy loan does not have to be repaid before the policyholder dies — however, the death benefit will be reduced accordingly if a loan is not repaid before death.
How does infinite banking work?
Here is a simplified step-by-step explanation of how the infinite banking concept works to help you understand why some are advocating in favor of it.
- The basis of the infinite banking concept is a whole life insurance policy. So, buying a whole life insurance policy is the first step to enacting an infinite banking strategy.
- As you pay premiums, the cash value of your policy increases. The cash value also continues to grow at a rate set by the insurer. If you’re using a mutual insurer, you might also learn annual dividends.
- If you need liquidity and the cash value of your policy is high enough, you can borrow money using the cash value of your whole life insurance policy as collateral. These loans typically have a lower interest rate than personal loans, are more favorable from a tax perspective and don’t require you to pass a credit check.
- If your policy is still active when you die, the beneficiaries of your life insurance policy will receive a death benefit.
The pros and cons of infinite banking
Now that we understand the key concepts behind infinite banking, let’s delve into this strategy’s main benefits and disadvantages.
The benefits of infinite banking
Let’s first explore the benefits of the infinite banking concept.
Tax advantages
In most cases, the growth of the cash value of a whole life insurance policy is not taxed. In addition, loans that use the cash value as collateral aren’t taxable either. Still, make sure to talk to a tax consultant before making any financial decisions.
Easier borrowing
It’s much easier to get a loan against your whole life insurance’s cash value than it is to get a loan from traditional lenders. If your policy’s cash value is large enough, you will be able to borrow funds against it for any reason and without needing to pass a credit check.
Fixed returns
The cash value of a whole life insurance policy grows at a rate that’s fixed by the insurer. You can also earn dividends on an annual basis if you took a whole life insurance policy with a mutual life insurer.
Loan repayment flexibility
If you take a loan against the cash value of your whole life insurance policy, there is not a set date by which you have to pay it back. However, if you don’t pay the loan (plus interest) back before you die, the beneficiary of your life insurance policy will receive a smaller death benefit.
The disadvantages of infinite banking
While the infinite banking strategy does have its upsides, it also has some clear disadvantages. Here’s what to look out for if you’re considering following the infinite banking concept.
Poor liquidity at the start
Before you can take a loan against the cash value of your whole life insurance policy, the policy’s cash value needs to grow to a certain amount. Reaching this threshold can take a long time, depending on how much money you’re paying into your policy’s cash value.
At the end of the day, it’s important to understand that whole life insurance policies are not designed with the infinite banking strategy or investment in mind, as they are primarily meant to leave a death benefit to those closest to you in the event of your passing. Remember, it’s called a life insurance policy, not an infinite banking policy.
You might not be able to afford it
In order for the infinite banking strategy to work, you’ll likely have to overfund your whole life insurance policy. In many cases, people allocate 10% of their income each month to their whole life insurance policy, which you might not be able to afford depending on your financial situation.
Complexity
Successfully implementing an infinite banking strategy is not simple and requires quite a bit of financial know-how. Make sure to speak to a financial advisor before making any major financial decisions.
The bottom line
Infinite banking can provide a surprising amount of flexibility and cash flow, and is an interesting alternative to using traditional banks to finance a purchase or business investment. However, infinite banking is not for everyone, and executing this concept successfully requires you to be savvy with your finances.
If you are thinking about life insurance but don’t want to go the infinite banking route, a term life insurance will likely make more sense for you. Unlike a whole life insurance policy, a term life insurance policy provides coverage for a pre-determined amount of time, for example 10 or 20 years.
If you want to explore more topics related to investing, make sure to check out our article highlighting the best stocks to buy right now.
Source: https://coincodex.com/article/34031/infinite-banking-concept/