Instead of borrowing money from a bank, why not borrow from yourself? Here are the pros and cons to infinite banking and if it is right for you.
If you need to get a loan, where do you turn? If you’re like most people, you’ll likely go to a bank, credit union, or other lending authority to borrow money. However, while this process is quite common, it does have one glaring downside –
You’re paying interest to someone else.
What if, instead of borrowing from a third party, you borrowed from yourself? Obviously, if you had the cash in your bank account, you wouldn’t need to take out a loan. However, we’re not talking about borrowing from a savings or checking account. Instead, you can take money out of your long-term investments – specifically, whole life insurance.
In this article, we’re going to discuss the ins and outs of what’s called infinite banking. We’re also going to go over the pros and cons of this system to determine if it’s right for you. As with all investment strategies, the more you understand how it works, the better you can assess the benefits and risks.
What is Infinite Banking?
This concept is not that new, but it’s been gaining steam in recent years. The primary component of infinite banking is that you use your own assets as the bank. While that does sound appealing, the way it works is somewhat complicated. Here’s a quick breakdown.
Whole Life Insurance
To make infinite banking work, you need a whole life insurance policy. Additionally, the plan has to have sufficient funds for you to borrow against when you need it. For example, if you have to take out a $20,000 loan, but the cash value in your insurance is only $10,000, you’ll have to find a secondary source for the remainder.
Cash Value as Collateral
We’ll get into this later on in the article, but one of the benefits of infinite banking is that you’re not swiping from your own assets. The way that whole life insurance is set up, the money comes from the insurer, not your cash value.
Instead, your policy is designated as collateral. So, if you don’t repay the loan, the insurance company will simply take the funds from your coverage.
Overfunding your Policy
When you get a whole life insurance policy, a portion of your monthly payment goes toward the cash value. If you only made minimum contributions, it would take years to accumulate enough money for infinite banking to work. However, with infinite banking you’re overfunding your whole life insurance policy so you can borrow against it later.
The Pros and Cons of Infinite Banking
Overall, if you can make this strategy work for your needs, it could be beneficial.. However, you need to understand the potential pitfalls and obstacles you will face along the way. So, with that in mind, let’s dive into the various advantages and disadvantages offered by infinite banking.
If you’re unfamiliar with this term, a correlated asset is tied to the stock market. So, if the market goes up, your investment does as well. Most all types of stocks are correlated assets. Whole life insurance, however, is not affected by the market. So, even in a downturn, you don’t have to worry about losing money.
Because your policy is non-correlated, infinite banking can work as a viable loan strategy for emergencies. For example, if there is a market crash or recession, you can still borrow against your cash value to cover bills and expenses until things return to normal. With correlated assets, borrowing against them during a downturn is a bad strategy, since you’ll wind up losing more money when reinvesting later on.
Con: Infinite Banking Takes Time
If you need money right away and don’t have cash value built up, you can’t take advantage of this system. Even if you started adding money to your policy right now, it would take years to build up enough to utilize the funds effectively.
Depending on your current situation, the fact that infinite banking is a long-term strategy could make it a non-starter. For example, if you’re already close to retirement, chances are you won’t be able to contribute much to the plan before needing the money.
However, on the flip side, if you’re relatively young, you could be in a position to take advantage of infinite banking.
Pro: Tax-Free Loans
Another considerable advantage of infinite banking is that these loans are not treated as regular income. So, even if you’re borrowing tens of thousands of dollars, you don’t have to pay taxes on the loan.
This tactic can really come in handy at times, such as during retirement. We’ll talk about how to maximize your infinite banking strategy later in the article.
Con: Contributing to the Plan Costs a Lot
As we mentioned, you will have to overpay your life insurance premiums every month to take advantage of infinite banking. Since such a small portion of your monthly payments go to the cash value, it could take decades to build up sufficient funding.
So, if you’re not equipped to overpay on premiums, this strategy is again a non-starter. Unless you plan on taking out loans during retirement, it may or may not be a good idea.
Pro: Tax-Deferred Growth
Because your life insurance policy is the collateral, you’re not actually taking any money out of it. This also means that your cash value will continue to grow, even while you’re paying back the loan. Also, considering that you’ll have to pay interest to the insurance company, this growth can help offset those losses.
Con: Limited Investment Opportunities
While being a non-correlated asset can be a benefit, it’s also a disadvantage if you’re trying to build long-term wealth. Yes, your cash value will appreciate over the years, but potentially not as much as other investments like mutual funds.
Overall, as long as you can contribute to other accounts as well as your life insurance, this strategy can be viable. However, if you have to choose between a 401(k) or infinite banking, we’d recommend the 401(k) instead.
Pro: Guaranteed Protections
All investment methods come with some level of risk, but infinite banking is relatively low-risk when you do it right. This is because, even though you’re borrowing against your cash value, your policy still maintains a death benefit. So, you get the best of both worlds – you can protect your loved ones when you die, and you can earn money while you’re still alive.
Also, if you get a policy with an insurance company that pays dividends, your cash value can grow even faster. Since the funds are guaranteed to remain the same (non-correlated), your earning potential is more significant overall.
Finally, depending on the policy you get, you can lock in premium rates for the long term. This means that you don’t have to keep increasing your contributions to keep up with rising monthly costs.
Pro: Money-Making Potential
There are two primary reasons to invest in the infinite banking concept. First, to have more reliable access to liquid assets, all while avoiding credit checks and debt accrual. The second reason is to use infinite banking as a money-making opportunity.
We recommend going this route if you want to be more proactive and aggressive with your investments. Here’s an example of how it can work.
Let’s say that you know someone who wants to flip a property for profit. You borrow against your cash value (i.e., $40,000) and loan that person the money. Then, you charge higher interest than what the insurance company is charging you, and you make sure to set up a similar repayment schedule. Fortunately, you can customize your own repayment plan with the insurer, so this step is easy.
Finally, once the person flips the house and gets a profit, you get your money plus interest. In addition to the income from the interest payment, your cash value also grew during that period. Essentially, you doubled your earnings.
Obviously, there can be risks to this – for example, what if the home doesn’t sell before the loan is due? What if the person flipping the house abandons the project or skips town?
Even with those risks, your cash value is still the collateral. So, you’re not paying anything out of pocket. Compared to other investment strategies, infinite banking can be less risky overall.
Comparing Infinite Banking to Other Self-Funded Strategies
Now that you know what to expect from infinite banking, you may be wondering how to maximize its profitability. Also, if you’re familiar with other liquid assets, such as your 401k, you may think that they can be used as well. With that in mind, we want to illustrate the pros and cons of using whole life insurance compared to other long-term growth assets.
Indexed Universal Life Insurance
When picking out a whole life insurance policy for infinite banking, you might notice that an indexed universal plan can look more appealing. Since the program is somewhat tied to the market, it can earn more interest than whole life insurance. However, while that may be true on paper, in practice, it can be much more of a risk. Here are some core comparisons to understand.
Indexed Plans Can Lose Money
While the insurance company will mitigate your losses, a significant downturn can impact your cash value. Also, fees can outpace growth in the long-term, which will further eat away at your funds.
Harder to Get a Loan
With a whole life insurance policy, borrowing against the plan is easy. Infinite banking loans are much more challenging with universal life insurance because of the way it’s set up.
Premiums Can Fluctuate
Indexed policy rates are much more flexible, which can be both beneficial and detrimental. The insurance company can raise your premiums as you get older, which means less of your contributions go toward the cash value.
Individual Retirement Account or 401k
One investment strategy that many investors highlight is borrowing against your retirement accounts. The primary benefit of this method is that you’re paying interest to yourself instead of a third party. So, if you hate the idea of giving free cash to your insurance company, utilizing your 401k might seem appealing.
The significant downside to this option, however, is that your funds won’t appreciate while the loan is out. Since you’re taking the cash from your account, they can’t grow. By comparison, the insurance company is giving you money from a whole life insurance policy, so the cash value remains intact.
Another disadvantage of a 401k loan is that it’s harder to qualify, and you can only borrow up to 50% of your contributions, up to $50,000. So, if you need more money than that or don’t have enough in the account, you’re out of luck.
Finally, with IRAs, you’ll likely get hit with a 10% penalty if the funds aren’t used for specific purposes, such as buying a first home. If you’re over 59 1/2, however, this penalty doesn’t apply.
Bottom Line: Infinite Banking Can Work, If You Know How
Overall, this strategy is ideal for those who can afford to put away significant funds every month. Since you’ll want to contribute to your whole life insurance and a 401k (and potentially a Roth IRA), you have to have money to do so. Also, since this method will take years to accumulate, not everyone has the time or patience to make it work.
Since infinite banking depends on finding the best whole life insurance policy, let NextGen Life Insurance help. We’ll find plans and rates to fit your budget so that you can take advantage of this strategy if it makes sense for you. Call us today to find out more.