When most people need a loan, they apply for a line of credit through a traditional bank and pay that loan back, over time, with interest.
But what if you could take a loan from yourself? What if you could avoid the big banks altogether, be your own bank, and supply yourself with your own line of credit?
For physicians and other high-income earners, this is possible to do with infinite banking.
Infinite banking isn’t for everyone, but it does provide some unique benefits. Here’s a financial advisor’s review of infinite banking and all the pros and cons involved.
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What is Infinite Banking?
Infinite banking is a personal banking strategy developed by R. Nelson Nash. In his book Becoming Your Own Banker, Nash explains how you can use a permanent life insurance policy that builds cash value and pays dividends — thus freeing yourself from having to borrow money from lenders and pay back high-interest loans.
Nash created the concept of infinite banking after making a career switch from forestry into the insurance industry. And while not everyone is on board with the idea, it has challenged hundreds of thousands of people to rethink how they bank and how they take loans.
Between 2000 and 2008, Nash released six editions of the book. To this day, financial advisors ponder, practice, and debate the concept of infinite banking.
But a life insurance policy alone won’t make you an infinite banker overnight. The infinite banking concept (or IBC) is a bit more complicated than that.
How Infinite Banking Works
The basis of the infinite banking concept starts with permanent life insurance. Infinite banking is not possible with a term life insurance policy; you must have a permanent cash value life insurance policy.
For the concept to work, you’ll need one of the following:
- a whole life insurance policy
- a universal life insurance policy
- a variable universal life insurance policy
- an indexed universal life insurance policy
If you pay more than the required monthly premium with permanent life insurance, the excess contributions accumulate cash value in a cash account. As your policy’s cash value grows, it grows tax-deferred, meaning you won’t have to pay taxes on those funds while they’re accumulating. If you hold that cash account until its maturity date, you can also borrow against that cash value tax-free.
Taking a policy loan against your cash value does not affect the death benefit that will pay out to your loved ones when you die. Your loved ones will still receive your lump sum death benefit when you’re gone.
The more you overfund your cash account each month, the faster you can accumulate a greater cash value. But with a dividend-paying life insurance policy, you can grow your cash value even quicker.
How Dividend Payments Work
One thing that makes whole life insurance unique is earning even more money through dividends.
Suppose you have a permanent life insurance policy with a mutual insurance company. In that case, you will be eligible to receive part of the company’s profits — just like how stockholders in the company receive dividends.
Dividends are not a guarantee, but when you do receive dividend payments, you have the option to:
- Use them to reduce premium payments
- Allow them to accumulate as cash toward your total cash value
- Use them to make paid-up additions
Paid-additions add to your death benefit and add a cash value to your accumulation account. By adding paid-up additions, you can also enjoy compound interest and grow your money even more.
Be Wary of the Modified Endowment Contract
With a cash-value life insurance policy, both gains and withdrawals are tax-deferred. If you overfund your insurance policy as a way to build your cash value faster, your cash value can switch from tax-deferred to taxable in an instant.
And that’s because of the Modified Endowment Contract (MEC).
There is a cap on how much money you can contribute to a life insurance policy, and that cap is determined, in part, by the amount of the policy’s death benefit. Practicing infinite banking may tempt you into overfunding your account as quickly as possible. However, by doing so, you could shift your insurance policy into MEC status.
Once your policy converts into a Modified Endowment Contract, cash contributions and cash gains on that account become taxable income. If you take a distribution against your account before the age of 59 ½, you’ll also have to pay a 10% penalty. The IRS has imposed the MEC rule as a way to prevent people from skirting tax obligations.
Infinite banking only works if the cash value of your life insurance policy remains tax-deferred, so make sure you don’t turn your policy into an MEC.
Different policies have different limits, so be sure you understand the terms of your policy before you overfund it in a way that makes it taxable. Once a cash value insurance account classifies as an MEC, there’s no way to reverse it back to tax-deferred status.
The Pros of Infinite Banking
Infinite banking is a viable concept that offers a variety of benefits. Here are some of the pros of this unique, personal finance banking system.
Cash Value Life Insurance Policies are Non-Correlated Assets
A non-correlated asset is any asset not tied to the stock market. And since the cash value of a whole life insurance policy or universal life insurance policy is a non-correlated asset, you won’t have to worry about losing money as the market fluctuates up and down.
You can reap the benefits of infinite banking with a variable universal life insurance policy or an indexed universal life insurance policy. But since these types of policies tie to the stock market, these are not non-correlated assets.
For your policy’s cash value to be a non-correlated asset, you will need either whole life insurance or universal life insurance.
Tax-Free Growth
Policyholders that contribute to a permanent life insurance policy with dividend payouts can enjoy tax-free growth. Before selecting a policy, find out if your life insurance company is a mutual company or not, as only mutual companies pay dividends.
Tax-Free Loans
The next time you need a large sum of money to make a down payment on a home, pay for college tuition for your children, or fund a new investment …
You won’t have to dip into your savings account or search for lenders with low-interest rates.
Infinite banking offers peace of mind, as you can take a tax-free loan from yourself.
Having cash value in your life insurance policy is like having an additional personal bank account. When it’s time to pay the loan back, you’ll pay it back to yourself instead of a third party.
Even with an accumulated cash value of a few thousand dollars, extending your own loan to a child or a trusted family member can be beneficial.
For example, if you have a child with a low credit score (or no credit at all), offering them a personal loan can save them having to rack up debt on credit cards.
By taking a loan from you as opposed to a traditional lender, the borrower can save thousands of dollars in interest over the life of the loan. (Just be sure to charge them the same rate of interest that you have to pay back to yourself. Otherwise, you’ll take a financial hit).
More Liquidity
You can increase your cash flow and have greater access to liquid assets with a cash value insurance policy. Having access to cash is critical in an emergency or when an investment opportunity arises. Building cash value in your life insurance policy makes it easier to tap into your own personal funds when you need them.
Use Your Life Insurance Policy to Make Other Investments
The cash value of your life insurance policy is yours to borrow against or make withdrawals from. You can use those loans and withdrawals to make bigger, better, more profitable investments.
For example, you could take a loan on your life insurance policy to buy a piece of real estate. Flipping a house or buying a rental property is an excellent way to take a small initial investment and enjoy a high rate of return.
You could also:
- Withdraw a portion of your cash to invest into a mutual fund
- Pay down personal debt
- Start your own practice
- Become a partner in an existing practice with other business owners
As a physician with a high annual income, many investment opportunities exist.
The Cons of Infinite Banking
Contrary to what some people may think, infinite banking is not a scam. It’s just another way to defer paying taxes on a portion of your income and create another safety net for yourself and your family.
But there are some drawbacks to this banking method.
Building a High Cash Value Takes Time
Because of the MEC law, you cannot overfund your insurance policy too much or too quickly. It can take years, if not decades, to build a high cash value in your life insurance policy. The amount of money in your account can only grow as fast as Modified Endowment Contract law allows.
You Can Make More Money With Other Investments
Stocks, bonds, and real estate offer faster and higher rates of return than stockpiling cash in a savings account or a life insurance policy.
Before you decide to start overfunding your life insurance policy in an attempt to practice infinite banking, you should consider if other investment opportunities can make you more profitable in a shorter amount of time.
You May Not Qualify for a Permanent Life Insurance Policy
Infinite banking is only possible with a permanent life insurance policy, and not everyone qualifies for one. A life insurance policy ties to your health and life expectancy. Therefore, most insurers need a health exam or medical screening before the underwriting process can begin.
Depending on your medical history and pre-existing conditions, you may not qualify for a permanent life insurance policy at all. And if you don’t qualify, infinite banking the R. Nelson Nash way won’t be possible.
Is Infinite Banking a Good Choice for Physicians?
Tired of relying on traditional lenders and big banks? Fed up with paying high-interest rates when you need to take out a loan?
With infinite banking, you can become your own banker, borrow from yourself, and add cash value to a permanent life insurance policy that grows tax-free.
Infinite banking can be a peace-of-mind solution for physicians, but it’s one of many strategies that you can use. There are some other financial obligations that you should also focus on meeting.
Make the maximum yearly contributions to your IRA or other retirement savings account. Invest in real estate, mutual funds, and stock and bonds that offer high annual rates of return. Protect yourself with disability insurance. Ensuring that you’ll continue to earn future income even if you become ill or suffer an injury that prevents you from doing your job.
Infinite banking has many advantages. When done properly, it can be as powerful a financial tool as having disability insurance, sound investments, and a robust retirement plan.
Related reading: Everything You Need to Know About Physician Retirement.
To make infinite banking work for you, you’ll need to have patience. It takes time (and a good bit of money) to fund the cash value of your life insurance policy to a point where you can withdraw from it when you need a loan.
If you’re looking to build significant wealth, infinite banking can serve as yet another profitable investment in your future.
Ready to find a life insurance company and the life insurance policy that’s right for you?
Contact Physicians Thrive now for more information about life insurance, disability insurance, and planning for retirement.
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