Tier One: Infinite Headaches from Infinite Banking
At Life Insurance Strategies Group, we love our TikTok, especially the ‘cooking’ segments, “Everyone’s so creative!” Along with those hilarious videos touting the benefits of using cheese in every recipe, TikTok users are served up an endless number of videos promoting “infinite banking.” Viewers are inundated with suggestions that they become their own bank by purchasing a life insurance policy – usually a whole life insurance contract. The content creators claim that lots of super rich people are their own banks because of how they use their whole life insurance policies. This simply is not true and adopting infinite banking as described on TikTok and on other platforms likely brings more financial risk than benefits.
What is Infinite Banking?
Infinite banking is a strategy whereby the ability to take withdrawals and loans from a cash value policy is exploited in a manner that a policyholder is led to believe they can take frequent distributions and make occasional premium payments whenever they feel the need to do so. The premise is that the money in a cash value life insurance policy grows tax-deferred, unlike in a bank account, so why not keep most or all of your money in a policy and access it like you would at bank, replenishing as needed?
Whole life policies are the favored policy type for promoters of infinite banking for two main reasons. First, the salesperson does not have to have securities licenses to sell whole life – just a state insurance license. This means there is a lot less regulatory oversight on sales practices, including compliance review of selling language and it is harder to find if there are customer complaints. For those professional life insurance producers who have securities licenses, a background check can be performed at Finra.org.
Second, whole life insurance policies are expensive and pay proportionately significant upfront commissions. A primary reason whole life is expensive is that the death benefit is usually guaranteed as long as the premiums are paid as laid out by the insurance company in the policy contract. The guaranteed death benefit makes whole life suitable for estate planning where liquidity is needed to pay transfer taxes or to see to the care of family members left behind. Whole life would not be a professional life insurance producer’s recommendation as the top choice to use for accumulation. This is just one of the weaknesses of infinite banking.
The Foundation is Sound
The future income policy feature at the heart of infinite banking is actually a major reason policyholders purchase cash value policies. By overfunding a cash value policy and purchasing as little death benefit as regulations allow, a policyholder can leverage the tax-free build-up of cash value. Later, usually 15 or more years in the future, distributions can be taken from the policy to provide an income stream to the policyholder. This money can be used for retirement, to buy a second home, to pay for a wedding or the policy can go untouched and the built-up cash and any death benefit can be passed to heirs income tax-free. Usually, a life insurance company will permit withdrawals and policy loans up to 90% of a policy’s cash surrender value.
This strategy works best when, at the time the policy is purchased, the policyholder has a plan for when distributions will occur and funds the policy accordingly. For instance, if distributions will be in 15 years and not in 25 years, the policyholder may want to accelerate the amount and/or timing of premiums so that more money is growing tax-free within the policy and early distributions can be supported.
Even if unplanned distributions are needed for liquidity emergencies, these can be accomplished with usually only a little change to future funding and an established future distribution strategy to return the policy to where it is still meeting the original planning goals.
Generally, less expensive policies that have more potential for cash value growth are used for a future income strategy. Policies such as variable universal life, universal life and index universal life are typically preferred over whole life versions.
A life insurance company is not a bank, and a life insurance policy is not a bank account.
Infinite banking seeks to abuse the distribution capabilities of a cash value policy by suggesting frequent, unplanned ‘withdrawals’ are not problematic. What is the harm? The damage is most evident if the policy eventually lapses, and all the previously tax-free policy loans are then taxable at ordinary rates.
A solution to this might be for the policyholder to step in and make additional premium payments to keep the policy going so that the tax bill does not come due. Either way, this decision is most likely to arise in future years when the policyholder is older, even elderly. It may be that the policyholder will not be in a financial position to pay additional premium, giving them no choice.
Next, whole life and other cash value policies almost always have surrender charges. Taking withdrawals before those charges have expired in 15 to 20 years means the policyholder encounters that charge. Infinite banking claims tend to leave out the part about penalties for accessing the policy any time in the near future.
In addition, taking distributions from a whole life policy eliminates the guarantee that the policy will remain in-force as designed. Distributions are not the only culprit – loans taken have interest assessed and this builds up the loan balance. Many whole life insurance companies charge 8% interest on loans. Banks, of course, do not charge interest for withdrawals.
The question least addressed in infinite banking claims is “who is tracking all the distributions and unplanned premium payments (if any)?” Those familiar with life insurance company administrations systems, especially those systems designed to administer whole life insurance policies, know the systems are not built to track a volume of transactions and to automatically and quickly produce recalculated policy performance illustrations.
Essentially, the more a policyholder transacts with a whole life insurance policy, the more blind they will become to their current position with respect to withdrawal and loan balances, interest rate assessments, surrender charges, loan repayment or new premium payment options and the ability to assess if a policy is in danger of lapsing.
You Thought ATM Fees Were Bad
Perhaps most revealing about the infinite banking scheme is that it is not a strategy promoted by life insurance companies but mainly by a lower tier sub-set of producers. In fact, major insurer MassMutual recently told its licensed producers to not position life insurance as a checking, savings, or retirement vehicle, or something other than life insurance.
It may be that the life insurance industry will need to fund a TikTok campaign to sound the alarm about infinite banking in order to reach the same audience.
Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.