When people have infinite banking explained to them for the first time it seems like a magical and risk-free way to grow wealth. The idea of replacing the hated bank with borrowing from yourself makes so much more sense. But it does require replacing the “hated” bank for the “hated” insurance company.
Usually the biggest adherents of infinite banking are those getting paid to be a big fan. Of course insurance companies and their agents love the concept. They invented the sales pitch to sell more whole life insurance. But does the sales pitch live up to real world experience?
In this article we will first “do the math” on infinite banking, the bank with yourself philosophy. Because fans of infinite banking might claim I’m being biased, I will use screen shots from a proponent’s video and link the entire video at the end of this article.
Once I expose the fatal flaws within the infinite banking concept I will share a strategy that actually delivers on the promise of infinite banking without the need of a bank or insurance company. There are no products to buy and I will sell you nothing. You keep all the money!
There are two serious financial disasters built into the infinite banking concept. I will expose these flaws as we work through the math of how infinite banking really works and how you can do much better.
What is Infinite Banking?
Infinite banking is a twist on the sinking fund. In a sinking fund money is saved to fund the purchase of a big ticket item, say a vehicle.
Infinite banking swaps out the bank deposit with the insurance company and uses a good story to convince you the insurance company has a better deal, plus you get life insurance.
Except that is not exactly true. The insurance company can no more give you a free ride than a perpetual motion machine gives free energy. Nothing works that way.
Because my bias is against infinite banking, I will use screen shots from a video from Cash Flow Hacking/LIFE180, an infinite banking proponent.
The promise of infinite banking is that a “properly structured” whole life insurance policy provides a safe place to save money so you can borrow from yourself at a future date to invest in income producing assets. If the whole life insurance policy is structured properly (placed with an insurance company that pays interest even on funds you have borrowed out) you can double dip by borrowing from yourself to buy income producing assets while at the same time still earning interest on the full value of the account in the whole life policy. This, in theory, super-charges your ability to grow wealth.
Now let’s see where it all goes wrong and usually leads to financial collapse.
Fatal Flaws of Infinite Banking
Infinite Banking Vs the Sinking Fund
The above screenshot of the LIFE180 video is how the presenter views a sinking fund.
In a sinking fund you save money to handle large future purchases. For example, you may save a monthly amount in a sinking fund to replace your car. You then buy the car with cash.
The argument made in the LIFE180 video is that you never get anywhere with a sinking fund. You deplete the fund when you pay cash for the car and replenish the sinking fund only to the previous level. That is a massive misunderstanding of the sinking fund!
The money in a sinking fund earns interest. When you use the money to pay cash for a car, what infinite banking calls borrowing from yourself, you pay the sinking fund back with interest. That is how you keep up with inflation. The sinking fund is always growing via interest from the saving account or from your car payments to your vehicle sinking fund.
It also happens to be what infinite banking conveniently forgets for the sinking fund and has excellent recall when applied to their life insurance product.
Infinite Banking’s Rate of Return Sucks: Part 1
What is that old saying? Figures don’t lie, but liars figure.
Well, I’m not calling anyone a liar. I am calling the math into question, however.
In the video we hear our first excited brag. See the $22,097 highlighted? That, we are told, is the increase in our cash value in year two.
But let’s dig a bit here. The real brag should be that you contributed $220,000 to the infinite banking policy and still only have a Cash Value of $207,728, a loss of $12,272 up to this point. Buuuuut. . .
The $22,097 highlighted in the video comes from the “Non-Guaranteed” columns. The “Guaranteed” amount is less. Aaaaaand. . .
You still have a loss regardless what column of the projection you use.
Of course you can “borrow” some of your own money if you want. More on that later. First we need to talk about. . .
Infinite Banking’s Rate of Return Sucks: Part 2
Now we turn to the longer term rate of return with infinite banking.
Before we reveal the true long-term rate of return in the whole life policy projection of a promoter of infinite banking, let’s ponder the idea of tying so much money up in what in the video is described as a savings account. The whole (pun intended) premise of infinite banking is to have an ever growing pile of money in a low-yield savings account. The only way to turn this into a win is to use faulty math.
But first, review the future value calculator below. (You can use a variety of other calculators to get the same results.)
After 10 years you manage a bit more than a 2% annual rate of return.
Of course, the infinite banking cheerleaders will have you believe you can borrow out “your own” money and invest it in other income producing investments. The idea is to get you to believe you can earn money on the money borrowed from your infinite banking account while simultaneously collecting a profit on other investments with the same money.
Which leads us to the next fatal flaw.
Infinite Banking Loans Are Not What You Think
When you take a loan from your whole life insurance policy what really happened?
First, the cash value is a contractual promise. The money is really in the general fund of the insurance company. (We will discuss this important point in greater detail below in the last fatal flaw we will discuss on infinite banking before turning to two alternatives that actually work.)
Let me make this more clear. The cash value belongs to the insurance company. It doesn’t belong to you.
The “properly structured whole life policy” bandied about by sellers of infinite banking is really just a life insurance company that is owned by policyholders and pays a dividend. The only reason they pay a dividend (the interest your cash value earns while borrowed out) is because they overcharged you for the life insurance.
The math of infinite banking loans also mask a cruel truth.
Each insurance company is different so my example is not a perfect match to all “properly structured” infinite banking examples.
It works like this. When you get a loan of “your” cash value you pay interest. THIS IS AN ADDITIONAL FUNDING OF YOUR INFINITE BANKING ACCOUNT AND NOT REVEALED IN THE ILLUSTRATION! Imagine if they would have added these amounts to their sinking fund example.
Worse, the insurance company may charge 5% while crediting your cash value 3% on the monies borrowed out. $1 million in loans means you are pumping an additional $20,000 per year into your whole life policy. This further reduces your rate of return. If you don’t make payments, no problem. . . as long as you have enough cash value to pay for the interest, thereby increasing your loan amount. When the cash value runs out the policy lapses and tax problems follow.
Even if the insurance company credited your cash value for 100% of the interest you are paying on the loan, you are still not getting a free ride. YOU are paying for the interest credited to your cash value for the amounts loaned out!
Yes, each insurance company whole life policy “properly structured” for infinite banking will vary. But it is easy to see you are not getting something for free.
If you use this same method with a sinking fund, as we discussed above, your account balance (a de facto cash value, if you like) will increase. And that is what you want from your sinking fund if you want to maintain buying power as prices climb over time. No magic involved.
Now we turn to the last fatal flaw if infinite banking we will discuss in this article before offering two methods that do work, no insurance required.
You Can’t Have Your Cake and Eat It Too
Here is one nightmare infinite banking proponents never want to talk about.
When you die, what happens with your whole life insurance policy?
Your beneficiaries get the death benefit, as promised in the contract between you and the insurance company.
What happens to the cash value?
The insurance company keeps it!
Remember when I mentioned the loan from your cash value comes from the insurance companies general fund? Well, that is because the cash value belongs to the insurance company. You have a right to “borrow” from this cash value, but make no mistake, all that cash value belongs to the insurance company, not you. The insurance company has a contractual obligation to loan you money under certain terms outlined in the policy until you die.
In the screenshot above you can see that if you died in year 23 of the policy (at age 63 in their projection), your beneficiaries will receive $1,607,546 in death benefits. The cash value stays with the insurance company, properly structured for infinite banking or not.
I could go on, but you get the point. There are many fatal flaws to the infinite banking concept. Life insurance companies and insurance agents love the concept and have ample reason to be blind to the fatal flaws. In the end there are only a few reasons for using permanent life insurance and infinite banking is not one of them, no matter how “properly” you structure the policy.
Infinite Banking Alternatives
The first infinite banking alternative is only available to certain people (people with debt or a mortgage works best). This in no way means you need to go into debt so you can use this strategy. The next strategy is a variation of this strategy where no debt is necessary. The only reason why I start with this strategy is because it can generate a larger return for some people and it also helps you “get out of debt faster.”
Here is how this strategy works:
- You will need a mortgage and line of credit.
- You move a portion of your regular mortgage to the LOC. Your regular mortgage is now paid down a bit more than it would have been.
- Instead of keeping more than a token amount in your checking account to pay bills you will drop the money into the LOC. You now pay no interest since that amount is no longer borrowed.
- When you need money to pay bills you can transfer money from the LOC back to your checking account.
- Your rate of return on your everyday float is the rate of interest on the mortgage.
CAUTION: If your LOC has a higher interest rate than your mortgage this strategy runs into problems. When interest rates were very low for a decade this strategy worked better. If your mortgage has a higher rate you can still use this strategy as long as the LOC interest rate is similar or lower than your mortgage interest rate.
The second infinite banking alternative anyone can use.
Infinite banking, as promoted by insurance agents, is designed as a big savings account you can borrow from. Your original money keeps earning even when borrowed out to you while the borrowed funds are invested in other income producing assets, the so-called double dip.
As we saw above, the insurance company is not the warm, fuzzy entity handing out free money. Your money is still growing because YOU are paying interest on the loan of your own money.
If you eliminate the insurance company and invest the same monies you will have more because you don’t have middlemen to pay. And the interest rate paid is probably higher, depending on current interest rates.
With this in mind, Treasury Direct is an excellent tool for building wealth with your excess funds earmarked for savings and no state income taxes. By purchasing short-term T-bills directly from the U.S Treasury your money is always liquid. You can withdraw your money at any time. You can always call it borrowing your own money if you want.
The same concept works with money markets accounts at financial institutions (banks or credit unions).
Here is the magic of infinite banking. When you borrow your own money you also pay yourself an interest rate. That is how the insurance company gets you to believe you are magically growing your wealth even while money is out on call (borrowed).
In a nutshell, this is the sinking fund. You pay interest as if it were a loan when you pull money from the fund. The infinite banking people want you to think this is only available from them, but it is such a simple concept (think Occam’s Razor) anyone can do it and insurance has nothing to do with it, structured or not.
What If I Need Life Insurance
Some people looking at infinite banking realize they have a temporary need for life insurance. Term life is the perfect solution to a temporary need for protecting against the loss of a breadwinner.
There are far fewer reasons for permanent life insurance. Key-man insurance and as part of a buy-sell agreement come to mind as a possible good reason to purchase a permanent life insurance policy.
In conclusion, there are no good reasons to engage infinite banking. It is a fancy term coined to sell high priced life insurance with ample commissions to the agent and massive profits to the insurance companies.
You can reach the same outcome as infinite banking with better results, more liquidity, no risk of a policy lapse triggering a massive tax problem and more options if you use my alternatives. I get no commission for selling you a product. My bias is good information so come back here and read more articles.
Compare that to the biases the promoters of infinity banking receive.
Here is the video from the promoter used in this article.
Saturday 4th of March 2023
Although I don't see myself climbing on to the infinite banking train anytime soon the one concept about this that I can appreciate is being able to borrow against an asset with a stable value and contractually guaranteed rates.
When you have a guaranteed return rate of 5% and can consistently borrow at 3% while using it as a storage place for cash (when not in use ) I can see how it would act as a supercharger to your savings over the long run. Even considering the initial drag up front.
Now, all of the downsides you've named are the reasons that I've never signed up but I would love to replicate some of the better parts of that with another asset class. HELOCs obviously have some of these same benefits but the contractual guarantee that you can borrow the money isn't nearly as strong and the ability to scale it is also fairly limited.
Treasury direct also offers some interesting options there but the liquidity isn't quite as simple (or free). At least based on my limited understanding.
Any suggestions on other asset classes that you could build a similar option around?
Thursday 2nd of March 2023
We do this with a first position HELOC. Our entire mortgage is a HELOC and allows us to paydown the mortgage early without losing control of the money. Very important issue for entrepreneurs!
Thursday 2nd of March 2023
Great article! Thanks for the info.
Thursday 2nd of March 2023
I appreciate the article as it helps to understand the concept better. The only thing I didn't see addressed is the tax sheltered growth that is promoted by the IBS concept. It seems to me a Roth would be a better route invested in index funds.
Friday 3rd of March 2023
@Keith Taxguy, EA, I've been pitched whole life as a way to shelter income form ordinary income tax on private money lending that I do. It has never sat well with me. Do you have any quick tips on lending private money in a tax efficient manner outside of a retirement account? I'm currently doing it through an LLC taxed as a partnership.
Keith Taxguy, EA
Thursday 2nd of March 2023
Jeff, I had to decide where I would make the cut on the info dump. Yes, there are tax advantages to the cash value life insurance policy. That doesn't affect the internal rate of return, but does affect the after-tax rate of return on outside investments. I did touch it a bit when I mentioned Treasury Direct is state income tax exempt.
The real truth? The math would have gotten messy and the post longer if I started breaking out the details. I think people do understand my concept however.
Thursday 2nd of March 2023
This is gold. I ran across the infinite banking concept awhile back and didn't spend the time to determine why it didn't quite sit right with me but it certainly wasn't making sense to my accountant mind. Appreciate you clearly laying things out.