Becoming your own bank with life insurance – aka, infinite banking – gets a lot of hype, but it’s important to understand what it can and can’t do before you decide if it’s right for you.
At its core, becoming your own bank is simply using a life insurance policy to finance things rather than turning to a bank or other financial institution. Infinite banking strategies are long-term financial planning strategies built around life insurance. They require consistent premium payments and careful loan management and typically start with a life insurance policy with a cash value component that can grow over time.
Build Cash Value Before Borrowing Against It
Once that cash value has had time to accumulate, policyowners may be able to use loans against the policy’s cash value to finance investments or purchases, cover unexpected expenses, or provide supplemental income during times of reduced cash flow.
The cash value component is important because cash value life insurance policies combine coverage with a savings element, as further explained at https://www.investopedia.com/terms/c/cash-value-life-insurance.asp. The savings portion can potentially help policy owners in the following ways:
- Access money for emergencies or supplemental retirement income
- Leave money to heirs
- Borrow against the policy’s value
- Potentially earn interest on policy loans
- Potentially help fund premiums
- Potentially increase the death benefit
- Potentially use excess cash value to buy additional insurance coverage
It’s also important to note that policies only have cash value if policy owners pay more in premiums than it costs the insurance company to provide coverage (aka, cost of insurance).
Examine Indexed Universal Life Policy Mechanics
IUL can offer flexible premium payments and the potential for cash value growth, but these policies can be complicated and require close examination, so ask Legacy Life Planning to map the policy mechanics to your goals before you proceed.
First, it’s important to remember that illustrations aren’t guarantees. Your policy’s performance will depend on many factors, including:
- How well your policy performs relative to the index it’s tied to
- Your policy’s cost of insurance
- Administrative fees
- Interest rates on policy loans
- How much you pay into your policy
Weigh the Upsides Against the Risks
The Upsides
- Access to policy loans
- Cash value that can potentially grow tax-deferred
- Death benefit protection for your loved ones
The Downsides
- Policy loans accrue interest
- Policy loans can reduce your death benefit
- Cash value growth isn’t guaranteed
- Becoming your own bank requires ongoing premium payments and careful loan management
- Infinite banking strategies aren’t one-size-fits-all; the right strategy for you depends on your unique financial situation and goals
Cash value life insurance can be an effective tool to provide flexible access to funds, but infinite banking strategies aren’t intended to:
- Replace an emergency fund
- Eliminate the costs associated with borrowing money
- Provide returns comparable to investments
Watch Your Loan Interest
Interest rates on life insurance policy loans vary by policy and carrier and are typically detailed in the policy contract. Failure to make policy loan payments may cause unpaid interest to be added to your policy loan balance. Over time, this compounding can negatively impact your policy’s cash value.
Check Whether the Strategy Fits Your Finances
Individuals interested in implementing infinite banking strategies typically:
- Have a need for permanent life insurance coverage
- Possess a long-time horizon and predictable cash flow
- Have already maxed out other savings and retirement opportunities and addressed high-interest debt
Individuals who may want to look into other financial planning strategies include those who:
- Are interested in accessing most or all of their life insurance premiums in a short period of time
- Struggle to cover monthly expenses
- Carry high-interest debt
Compare Alternatives and Test the Policy Assumptions
Compare Your Alternatives
Life insurance loans may allow you to avoid the hassles associated with applying for a loan, but it’s important to compare the interest rates and fees associated with policy loans to other potential sources of outside capital, such as a home equity loan, savings account, investment account, or other types of loans, before borrowing against your policy.
Start With Your Goals
Infinite banking strategies are highly individualized, so it’s important to first determine what type(s) of liquidity you’re seeking to create, whether that’s an income stream in retirement, business succession planning, family protection, or another financial goal, before determining what type and amount of life insurance coverage may help you achieve those goals.
Questions to Ask Your Insurance Professional
If you’re considering implementing an infinite banking strategy with a cash value life insurance policy, here are some questions to discuss with your insurance professional:
- Can you walk me through my policy illustration under different interest crediting and loan interest rate scenarios?
- What premiums will be required to keep my policy in force?
- How long will surrender charges be in effect?
- What happens if I stop making premium payments or decrease my premium amount?
Once your policy is in force, request periodic in-force policy reviews, especially if you’re considering changing your premium payment amount or taking out a sizeable policy loan. Bring your policy illustration, current loan balance information, premium schedule, and copies of any current life insurance policies you have in force to these meetings.
