Infinite Banking
Infinite banking or “Bank on Yourself” has been gaining traction over the last few years. In short, the concept is based on over funding whole life insurance and using the cash value to fund future expenses instead of borrowing or selling investments.
To place this concept into context we need to address a few hard truths. We have no control over three variables:
- Inflation,
- Future income tax rates, and
- Market returns.
In other words, the three most significant factors that will determine our standard of living in retirement are out of our hands. Congress decides how much you can spend in retirement. There are trillions of dollars in 401k and IRA accounts that have yet to be taxed. The government loves this. Fully 1/3 of your retirement money is not yours. It has never been yours and will never be yours. In effect, you have a silent partner (the IRS) who has the ability to change their ownership of your retirement fund without your consent. Most workers plow money into these accounts to lower their current income tax burden without thinking about the fact they may wind up paying even higher tax rates when the money comes out. I realize that company match programs make it very tempting to participate in company sponsored plans. These plans are not all bad. The issue is you need a hedge, a hedge against poor market returns and a hedge against higher tax rates.
One major component of infinite banking is your ability to pull money out tax-free without regard to whatever Congress decides later. Let’s break down the concept.
Two Clients
The best way to illustrate this financial transaction is to compare two 65 year old investors both in similar financial condition. One has a paid up $1mil whole life policy, the other does not. The investor with the paid-up policy has much more flexibility than the other investor. Both have large retirement accounts. The flexibility involves having the ability spend assets that will be replenished at death or using tax-free withdrawals to minimize the need to use heavily taxed IRA/ 401k assets. The client who does not have the $1mil must be much more concerned about leaving money for family members and does not have a large pool of tax free cash.
As mentioned before, infinite banking is nothing more than over funding whole life insurance so it develops cash value sooner and is paid up earlier. The IRS regulates how much money can be invested in life contracts. If their rules are violated, withdrawals may be taxable where the policy is considered a modified endowment contract. If set up correctly this will not happen. Below is an example of how this works. In our exemple a healthy 51-year-old male, non-smoker is buying $100,000 whole life policy with $425,000 of ten-year term. The normal premium is just over $5,000 per year. Instead, we are going to put $25,000 into it per year for ten years, either out of cash flow or by repositioning other assets. For the next five years, we are going to use dividends and cash values to pay the premiums for there is no out of pocket for five years. Under current dividend scales, the client may withdraw $25,000/yr for 16 years tax-free. Now at age 81, the client received $150,000 more than he put in and has had life coverage for 31 years paid for out of pre tax dividends. You will notice in the chart below that the client is never out of pocket more than $3665. The reason this is true is due to the fact that whole life premiums are NOT an expense – they are an investment, moving money from one pocket into another. The out of pocket amount reflects the total premiums paid and subtracting the cash surrender value.
| Age | Year | Premium | Surrender Value | Net Death Benefit | Annual Net Cost | Cumulative Net Cost |
| 51 | 1 | 25,000 | 22,289 | 577,441 | -2,711 | -2,711 |
| 52 | 2 | 25,000 | 46,435 | 632,127 | -854 | -3,565 |
| 53 | 3 | 25,000 | 71,479 | 685,631 | 44 | -3,521 |
| 54 | 4 | 25,000 | 97,733 | 738,317 | 1,254 | -2,267 |
| 55 | 5 | 25,000 | 124,986 | 790,457 | 2,253 | -14 |
| 56 | 6 | 25,000 | 153,275 | 841,757 | 3,289 | 3,275 |
| 57 | 7 | 25,000 | 182,638 | 892,314 | 4,363 | 7,638 |
| 58 | 8 | 25,000 | 213,110 | 942,190 | 5,472 | 13,110 |
| 59 | 9 | 25,000 | 244,730 | 991,422 | 6,620 | 19,730 |
| 60 | 10 | 25,000 | 277,538 | 1,040,068 | 7,808 | 27,538 |
| 61 | 11 | 0 | 287,684 | 626,356 | 10,146 | 37,684 |
| 62 | 12 | 0 | 298,095 | 626,356 | 10,411 | 48,095 |
| 63 | 13 | 0 | 308,756 | 626,356 | 10,661 | 58,756 |
| 64 | 14 | 0 | 319,689 | 626,356 | 10,933 | 69,689 |
| 65 | 15 | 0 | 330,887 | 627,328 | 11,198 | 80,887 |
| 66 | 16 | -25,000 | 316,336 | 582,472 | 10,449 | 91,336 |
| 67 | 17 | -25,000 | 301,007 | 538,447 | 9,671 | 101,007 |
| 68 | 18 | -25,000 | 284,884 | 495,148 | 8,877 | 109,884 |
| 69 | 19 | -25,000 | 267,937 | 452,500 | 8,053 | 117,937 |
| 70 | 20 | -25,000 | 250,153 | 410,459 | 7,216 | 125,153 |
| 71 | 21 | -25,000 | 233,587 | 367,164 | 8,434 | 133,587 |
| 72 | 22 | -25,000 | 216,263 | 332,170 | 7,676 | 141,263 |
| 73 | 23 | -25,000 | 198,154 | 297,619 | 6,891 | 148,154 |
| 74 | 24 | -25,000 | 179,245 | 263,443 | 6,091 | 154,245 |
| 75 | 25 | -25,000 | 159,531 | 229,579 | 5,286 | 159,531 |
| 76 | 26 | -25,000 | 138,666 | 206,236 | 4,135 | 163,666 |
| 77 | 27 | -25,000 | 116,584 | 181,641 | 2,918 | 166,584 |
| 78 | 28 | -25,000 | 93,211 | 155,741 | 1,627 | 168,211 |
| 79 | 29 | -25,000 | 68,465 | 128,485 | 254 | 168,465 |
| 80 | 30 | -25,000 | 42,265 | 99,810 | -1,200 | 167,265 |
| 81 | 31 | -25,000 | 14,527 | 69,644 | -8,714 | 164,527 |
In this example, the policy continues to age 120. The amount withdrawn may be changed to a different amount, or a different time period to accommodate the requirements at any given moment and the performance of the policy. For example, the client may not need the money at age 65, may need more than $25,000 or a $100,000 to buy an R.V. The possibilities are endless ONCE the policy has enough cash to sustain itself. Of course, you may not be 51, healthy or be able to fund what amounts to a $250,000 investment. This is an illustration that can be tweaked. The concept still works for older clients and clients with some health issues. Putting the right plan in place involves a detailed analysis of a specific situation and someone skilled in tweaking these policies. In addition to having access to a pile of tax-free cash, some of the policies have what is known as living benefits. Living benefits pay out a portion of the death benefit due to the diagnosis of critical illness like a stroke or heart attack, a chronic illness due to an accident, and a terminal illness. The days of benefiting only upon death are long gone.
About the Author:
David Disraeli has been in financial services for over 31 years. He is an author, speaker and financial advisor and the president of The Personal CFO, Inc. During his tenure, David has been an insurance agent, portfolio manager, stockbroker, Certified Financial Planner and financial analyst.