I have been asked on several occasions my thoughts on the Infinite Banking Concept (IBC) or System, both by clients and other brokers.
Basically, the idea is that you can become your own banker. Over time, you create a “bank account” by building cash reserves within a participating whole life insurance policy (i.e. one that pays dividends). You can then borrow funds from this account and pay yourself the interest, rather than paying another lending institution. By doing this, you not only save on interest, but your account continues to grow exponentially.
At least that is the theory.
First of all, let me point out that the concept is not a scam. It is based on the growth potential, built-in features, and operation of a participating whole life policy structure which has been around for more than a hundred years!
That being said, I must also point out that the concept is not for everyone. I will take it a step further and say that it is better suited to individuals that:
- Are high-income earners
- Have stable employment and cash flow
- Have no debt
- Are also contributing to other tax-saving vehicles (RRSP, TFSA, Leveraging)
- Who have some need for life insurance
I have heard and read many arguments to the contrary. Ultimately, however, ambiguity can be removed through mathematical analysis. Let’s quickly (you can definitely write a book on it!) examine a few claims one by one. This is by no means an exhaustive list:
“This is not an investment.”
Of course it is! Only that you are not in control. You cannot chose funds or how monies are being invested. A participating whole life policy contains a ‘par-fund’, which comprises of bonds, mortgages, interest on policy loans (more on that later), equities, etc. Dividends declared are based on the performance of this fund and are never guaranteed.
“The more you borrow from your policy, the faster it grows.”
I’ve heard this from almost every broker I have spoken to regarding this system (also referred to as interest volume).
To understand this, it must be known that participating whole life insurance or universal life policies can be overfunded (pay more than the prescribed premium). This is where the “interest” is being “paid”. So, obviously, the more “interest” or overfunding you pay, the faster the policy will grow.
However, you can grow your policy without ever borrowing. In fact, your policy will continue to grow completely independent of any borrowing taking place.
“Pay yourself the interest, not the bank”
This grabs a lot of attention. Who wouldn’t want to pay themselves the interest?
This isn’t entirely true. When you borrow funds from your own policy, you must also pay interest to the insurance institution. This is why the IBC tells you to pay yourself higher interest than what you would pay a bank.
To my knowledge, every participating policy charges interest (as of today, the lowest I’ve seen is 4.25%). In fact, this interest becomes an income component of the par-fund (the fund that drives the growth within a participating policy)!
“The tax-sheltered benefits accelerate cash value growth.”
For a policy to grow at maximum efficiency, the policy must be overfunded for several years by the maximum prescribed amount (called the MTAR line). If you are arbitrarily funding your policy through “loan interests”, you are paying more for the insurance policy than you have to.
It is also not entirely possible to ‘arbitrarily’ overfund a whole life policy. There are restrictions based on underwriting which renders the method inflexible. If you need the flexibility, then a universal life policy is required (but that’s an entirely different discussion).
“Better than a chequing account or mutual fund policy.”
This is an easy one.
Assume Jane, age 36, has $400 after-tax to contribute to any plan. Her marginal tax rate is 32% (she earns $40,000 annually). Note that I said “after-tax”. She must earn $588 before taxes to afford a $400 after tax purchase. For example, Jane must earn $588 to afford a $400 LCD TV, after taxes.
I ran an illustration to show how an optimally configured participating whole life policy would work for her over the course of 15 years. By optimally, I mean the death benefit is automatically reduced over time as the cash values increase and the policy is overfunded to the max.
After 15 years, the cash value of this policy is about $88,000. Technically, she can borrow up to 90% of this amount.
Could she have done better?
- Non-registered “mutual fund” or “segregated fund” solution:
After 15 years, and at an average growth rate of 6%, her net after-tax growth is about $110,000 (remember she must pay taxes along the way). - TFSA solution:
After 15 years, the TFSA grows to $117,000, tax-free. - RRSP solution:
We can contribute the entire $588 into the RRSP because of the tax deduction. After 15 years it has grown to $171,000. - Non-registered Leveraging solution:
This entails borrowing money to invest and paying only the interest on the loan. Since the interest is immediately tax-deductible, the full $588 contribution is allowed. At 6% loan interest, the leveraged amount is $118,000 (this is readily available through insurance leveraging programs to those with good credit). After 15 years, the net asset value is $134,000.
The cash value is inherently lower for the whole life IBC due to internal costs (cost of insurance, provincial tax on overfunding).
In each of the above instances (except the RRSP solution), the accrued amounts can be pledged as collateral for loans. Essentially, you are creating the IBC using other more efficient solutions. You are not bound to using a whole life policy. You can even combine solutions, such depositing RRSP refunds to a TFSA, further accelerating growth (and outperforming a whole life IBC).
In addition, although an RRSP policy cannot be pledged for collateral, it will have accrued substantial growth for retirement. She can use the tax deductions to pay down her debt. She can even give herself loans, such as a self-directed mortgage!
I only summarized the results from each concept. If you wish to have a detailed analysis or inquire about more advanced strategies, please feel free to contact me.
It’s not over yet! We’ve only scratched the surface. In my next blog entry I will discuss specific pros and cons for using the IBC with whole life or universal life insurance.
In the meantime, I welcome comments and questions.