Infinite Banking Explained: How It Works and Should You Do It?

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Infinite banking, which is also sometimes referred to as “banking on yourself,” is built on a compelling idea: use whole life insurance to let your savings grow tax-free and then lend yourself money at attractive rates from the policy’s cash value (also tax-free).

Too good to be true? In most cases, yes.

Infinite banking is an overly complex strategy with significant fees, risks, and opportunity costs. 

It requires substantial, consistent premium payments, and there’s a risk of losing coverage if you can’t keep up with the premiums. Even if you can pay them, it may take 10 years before there’s enough cash value to borrow against. 

Moreover, the returns on the policy’s cash value component are often lower than the returns on investing the same amount in a well-diversified low-cost portfolio, such as a mix of stocks and bonds (even when tax consequences are factored into the equation).

In this guide, I’ll explain infinite banking, how I arrived at the conclusion above, and explore alternative strategies.

Infinite Banking Strategy Explained

In theory, infinite banking allows your money to grow tax-deferred while giving you access to cash at favorable interest rates. The strategy was first detailed by economist Nelson Nash in his 2000 book Becoming Your Own Banker. 

Nash’s background was primarily in the insurance industry, having worked as a life insurance agent for over 35 years. Nash passed away in 2018, but the for-profit Nelson Nash Institute is still in operation and continues to promote the idea and educate practitioners. 

In a nutshell, here’s how the infinite banking strategy works:

1. Purchase a whole life insurance policy with a cash value component.
2. Overfund the policy in the early years by paying more than the minimum premium.
3. Use the dividends earned on the policy to purchase “paid-up additions” (PUAs), which increase the policy’s cash value and death benefit.
4. Borrow against the accumulated cash value tax-free at favorable interest rates.
5. Repay the policy loans while the cash value continues to grow, allowing you to borrow again.

The main benefit of this strategy is that it allows you to grow your wealth tax-deferred while providing access to tax-free funds through policy loans.

While these steps may seem simple, the devil is in the details. Implementing an infinite banking strategy requires careful planning and a thorough understanding of how whole life insurance policies work.

Term vs. Cash Value Life Insurance

For those unfamiliar with life insurance, it’s important to understand that it comes in two main types: term and cash value (also known as permanent). 

Term life insurance provides coverage for a specific period of time, such as 10, 20 or 30 years, and pays out a death benefit if the insured person dies within that period. Once the term expires, the coverage ends. (It also ends if, at any time during the term, you’re unable to pay the premiums.)

In contrast, cash value life insurance provides lifelong coverage and includes a savings component. This type of policy appeals to people who want permanent life insurance security as well as the potential to accumulate cash value (via the savings component) over time.

While it’s not an apples-to-apples comparison, as you’re getting added benefits with cash value insurance, the cost difference between term and cash value policies is significant. 

For instance, a cash value policy offering a $1 million death benefit might cost a 30-year-old approximately $10,580 in annual premiums. In contrast, a 20-year term policy for a similarly healthy 30-year-old male could be as affordable as $360 a year.

How Whole Life Insurance Works In Infinite Banking

Infinite banking uses whole life insurance, which is a type of cash value insurance that provides lifelong coverage, has fixed premiums, and includes a guaranteed savings component.

When you pay premiums for a cash value policy, a portion of the money goes toward the life insurance coverage, while another portion is allocated to the cash value. 

The cash value in a whole life insurance policy earns interest or investment returns, depending on the specific policy, and typically grows over time.

(Note that other types of cash value life insurance, such as variable life insurance, may offer investment returns that vary based on the performance of selected investment options.)

This growth is tax-deferred, meaning you only pay taxes on the gains once you withdraw the money. However, the accumulated cash value can be borrowed against, usually at interest rates that are lower than traditional personal loans. 

When you take a policy loan, you are technically borrowing money from the life insurance company, using your policy’s cash value as collateral. The life insurance company provides the loan, not you directly. These loans are tax-free as long as the policy remains in force.

Accelerating Cash Value Growth Through Overfunding

In a traditional infinite banking strategy, you intentionally pay more than the required minimum premium, especially in the policy’s early years. 

This extra payment is similar to making additional principal payments on a mortgage. 

Just as extra mortgage payments go directly toward paying down your loan balance, the excess premium paid into a life insurance policy goes directly toward growing your cash value. The key difference is that with life insurance, you’re building up an asset (cash value), whereas with extra mortgage payments, you’re reducing a liability (loan balance).

Borrowing Against Your Policy’s Cash Value

By overfunding the policy, you accelerate the growth of the cash value, which can then be borrowed against.

When you take out a policy loan, you’re not withdrawing money from the cash value but borrowing against it. The insurance company uses your cash value as collateral for the loan and charges interest on the borrowed amount.

These loans can be used for various purposes, such as funding investments, making large purchases, or covering expenses while allowing the remaining cash value to grow tax-deferred. 

Maintaining your policy with an outstanding loan requires managing the loan appropriately, including paying interest and potentially repaying the principal. Failure to do so can lead to the policy lapsing if the loan amount plus interest exceeds the cash value.

Policy loans are not the same as withdrawing money from your cash value. When you withdraw money from your cash value, you directly reduce the cash value in your policy and may be subject to surrender fees. 

In contrast, when you take a policy loan, your cash value remains intact and grows. Still, you use it as collateral to borrow money from the insurance company.

So, while the term “borrowing from yourself” is often used in infinite banking, it’s more accurate to say that you are “borrowing from the life insurance company” using your cash value as collateral.

Understanding Cash Value Growth In Whole Life Insurance Policies

Now that we’ve covered the basics of infinite banking, let’s dive deeper into how cash value grows within a whole life insurance policy. 

This is important for many reasons, but mostly:

1. It reveals the typical costs involved in implementing an infinite banking strategy.
2. It demonstrates the time needed to accumulate significant cash value for borrowing.
3. It illustrates the potential growth of your cash value over time.

A Real-Life Example of Cash Value Growth

To demonstrate this, let’s consider an example. 

Meet John, a healthy 30-year-old exploring infinite banking. John is considering buying a whole life insurance policy with a $1 million death benefit.

The table below shows the projected cash value growth for a $1 million whole life policy issued in 2023 by MassMutual, a well-known insurance company. These figures, published by Forbes, represent the actual premiums and expected cash value accumulation for a healthy 30-year-old male.

As the table above shows, when you buy a whole life insurance policy, a substantial portion of your premium initially goes towards covering the expenses of starting the policy and providing the death benefit.

As time goes by, more of your premium gets directed towards the cash value component. This is because the cost of providing the death benefit decreases as you age and pay into the policy, allowing a larger portion of your premium to be allocated to cash value growth.

How Cash Value Builds In a Whole Life Insurance Policy

Similar to an investment account, the cash value of a life insurance policy needs time to grow. 

In a traditional whole life insurance policy, the cash value growth is primarily determined by:

1. Guaranteed interest rate. The insurance company credits a minimum interest rate to the cash value, as the policy contract specifies. This guaranteed rate is typically lower than the expected return on investments, as it provides a safe and predictable growth component.
2. Dividends. Many whole life insurance policies are issued by mutual insurance companies, which may pay dividends to policyholders. These dividends represent a portion of the insurance company’s profits and are not guaranteed. However, when paid, dividends can significantly contribute to cash value growth, especially over the long term.

The goal is to pay into the policy long enough to benefit from the compounding effect of guaranteed interest and reinvested dividends. As the cash value grows, the dividends and interest earned in each subsequent year have the potential to grow as well, leading to accelerated growth over time.

Infinite Banking Example With Dividends Reinvested and Additional Upfront Payments

The policy illustration in the previous table assumed that the policyholder withdrew the dividends they received from the insurance company. But in a typical infinite banking strategy, policyholders use these dividends to accelerate the growth of their cash value.

Instead of withdrawing the dividends, policyholders use them to purchase “paid-up additions,” which are also called PUAs. 

PUAs are small, additional insurance policies that increase the overall cash value and death benefit of the main policy. When a PUA is purchased, it’s paid up in a single premium and adds a guaranteed cash value and death benefit to the base policy. 

The cash value of a PUA tends to be high relative to the single premium paid, making it an efficient way to boost the policy’s overall cash value.

By using dividends to buy PUAs, policyholders can further boost the growth of their cash value over time. The compounding effect of purchasing multiple PUAs over the policy’s life can result in a significant increase in cash value and death benefit compared to a policy where dividends are withdrawn.

Here’s an example to illustrate this concept…

Let’s say the policyholder, in addition to their regular premium, pays an extra $5,000 per year for the first 10 years. 

Instead of withdrawing the dividends earned on the policy, they use these dividends to purchase PUAs. These PUAs then contribute to the policy’s cash value and death benefit growth.

When you overfund a whole life insurance policy, as well as use dividends to purchase PUAs, as in the example above, the cash value builds faster. Plus, the death benefit builds over time. 

This accumulated cash value can then be borrowed against.

Since infinite banking aims to get policies functioning as self-lending platforms relatively quickly, overfunding premiums in the first 5-10 years is critical. Without this initial overfunding, it may take 15+ years before meaningful cash reserves accumulate for policyholders to borrow against. 

How Much Does Cash Value Compound Within a Whole Life Insurance Policy?

To fully understand infinite banking, it’s essential to have a solid grasp on the returns within a life insurance policy. 

Most policies provide returns through two key components:

1. Guaranteed interest rate. This contractually guaranteed growth rate is stated in the policy and generally ranges from 2% to 4% based on the type of policy, the age and health of the policyholder, and other underwriting factors. 
2. Dividends. Some whole life insurance policies, known as participating policies, may pay dividends to policyholders. These dividends represent a portion of the insurance company’s profits, which are generated from the company’s investments. Dividends are not guaranteed, but when paid, they typically range from 3% to 6% of the policy’s cash value. Instead of receiving these dividends as cash payouts in an infinite banking strategy, policyholders usually reinvest them back into the policy to increase the cash value growth further.

Combining the guaranteed interest rate of 2% to 4% with dividends ranging from 3% to 6%, we arrived at the 5.5% estimate used above to illustrate the potential growth of cash value in a whole life insurance policy.

How insurance companies handle your money is similar to how it’s handled within a mutual fund: after paying for their operating costs, insurance companies invest your premiums into a conservative portfolio of assets. These portfolios emphasize fixed income like bonds, while holding some public equities, real estate, and other diversifying investments.

So, cash value growth reflects a blended and relatively stable asset allocation model rather than what you’d get by owning the S&P 500. 

While there are indeed life insurance policies that tie their returns to the S&P 500 — known as indexed universal life policies — most proponents of infinite banking recommend whole life because they have more stable cash value growth and less risk of lapse. 

How Do Life Insurance Policy Loans Work?

An aspect of whole life insurance and an essential component of infinite banking is the ability to leverage your policy’s cash value for loans.

Life insurance loans are borrowed against the accumulated cash value within the permanent life insurance policy.

For example, let’s say John has a whole life insurance policy with a cash value of $100,000 in year 10. He wants to take out $50,000 for a down payment on a vacation home. John can borrow the money from his insurance provider, using his policy’s cash value as collateral.

The cash value as collateral allows for competitive interest rates compared to alternatives like personal loans or credit cards. Expect to find interest rates similar to those with a HELOC or a brokerage loan.

Direct Recognition vs. Non-Direct Recognition

When considering infinite banking, there is an important distinction to keep in mind: the difference between “direct recognition” and “non-direct recognition” whole life insurance policies, with regard to how they handle policy loans.

With a direct recognition policy, any loans taken out are first subtracted from the cash value balance before dividends are calculated and credited by the insurer. So, the policyholder earns dividends on less money.

In contrast, non-direct recognition policies, which are the type that proponents of infinite banking recommend, have dividends that accumulate on the full cash value even if money has been loaned out.

Suppose John has a non-direct recognition whole life insurance policy with a $100,000 cash value, earning 5.5% annually. He takes out a $50,000 policy loan at 6% interest. 

Here’s how this breaks down:

• John had $100,000 in initial cash value.
• He borrows $50,000, but the full $100,000 is still recognized for dividends.
• The entire $100,000 cash value still earns 5.5%, so it grows to $105,500 in one year.
• John owes 6% interest on his $50,000 loan ($3,000).

John now has three options with the loan:

• Pay the loan principal and interest out of pocket. John can choose to pay the $3,000 loan interest and any portion of the $50,000 loan principal out of pocket. By doing so, he reduces the overall loan balance and prevents it from growing due to compounding interest. This option helps stabilize the loan balance and minimizes the impact on the policy’s cash value.
• Do nothing and let the loan balance compound. If John does not pay the loan interest out of pocket, the $3,000 interest will be added to the loan balance, increasing it to $53,000 ($50,000 principal + $3,000 interest). If John continues not to pay the interest or principal, the loan balance will compound over time, potentially outpacing the cash value growth and putting the policy at risk of lapsing.
• Use the cash value to pay down the loan balance. John can use a portion of his policy’s cash value to pay the loan balance, including the principal and accumulated interest. For example, if John’s cash value has grown to $105,500, he could use $53,000 from the cash value to pay off the entire loan balance (principal and interest), reducing the loan balance to zero.

What else is essential to know about whole life insurance loans is that:

1. Life insurance loans have no set repayment period, but interest will compound.
2. If you die with a loan from the life insurance companies taken out, it will reduce the death benefit that is paid to your heirs.

What It Means When a Life Insurance Policy Lapses

Neglecting to repay loans from a cash value insurance policy can cause the policy to lapse.

A lapse occurs when the cash value of a life insurance policy reaches zero due to various factors, including the cost of insurance charges, policy fees, and the impact of policy loans and their associated interest charges.

If the policyholder fails to pay the required premiums and the cash value is fully depleted, the insurer will terminate the coverage since no funds remain to cover the ongoing costs and the death benefit.

What Are the Benefits of Infinite Banking?

With an understanding of how you can use whole life insurance and policy loans, let’s now evaluate some of the benefits of this strategy.

• Tax benefits. The cash value of a permanent life insurance policy grows tax-deferred. Policy loans also avoid income taxes if the policy remains in force. 
• Access to credit. The accumulated cash reserves provide a pool of savings to borrow from as needed at competitive rates. 
• Predictable returns. Projected policy dividends and interest rates on the policy’s cash value don’t fluctuate dramatically year-to-year like the stock market. While caps on growth exist, these guarantees provide some certainty compared to most investments.
• Flexible repayment. Rather than fixed loan repayment schedules, payback flexibility allows aligning payouts to personal cash flow timelines. No deadlines exist so long as cumulative interest doesn’t erode cash value collateral. 

What Are the Downsides of Infinite Banking?

First of all, let’s get some of the most obvious downsides out of the way:

• High capital requirements. Infinite banking relies on whole-life policies that require significant recurring premiums to accumulate meaningful cash reserves. 
• Delayed lending capacity. Unless you’re flush with cash today, it realistically takes 10 to 15 years of overfunded premium payments before adequate cash value exists for borrowing.
• Loan interest charges. While competitive loan rates apply thanks to the policy’s cash value collateral, interest costs must still be addressed. Either out-of-pocket payments or redirecting dividends to cover interest means gains are redirected from growth.
• Tax-consequences. If a policy lapses, any outstanding loans (and any accumulated interest which exceeds the premiums paid into the policy) get reported as ordinary income, triggering income taxes on money the policyholder never personally received.

These are just the surface-level drawbacks that need to be considered. 

So next, let me outline four big downsides that are not as obvious at first glance.

Downside #1: The Opportunity Cost of Investing Conservatively

Whole life insurance invests your cash value into conservative assets (primarily bonds) for decades. While safety has merits for near-term goals, bonds significantly trail the long-term return of stocks. 

In the example we used throughout this article, the policy’s $15,580 annual premiums produced $1,418,712 in cash value after 30 years, with a growth rate of 5.5%. 

Yet historically, simply buying and holding the S&P 500 returns about 8% annualized over long periods, even accounting for crashes.

And the power of compounding stocks over ultra-long holding periods is immense. Putting $15,580 annually into stocks at 8% would produce a balance of $3,798,787 over 30 years — or nearly twice as much as the life insurance policy.

Of course, the death benefit adds some value, so it’s not quite an apples-to-apples comparison. But this enormous gap illustrates the opportunity cost of locking up money for most of your working life in low-yielding assets.

This begs the following question: instead of going the life insurance route, why not just overinvest into a taxable brokerage account that you can borrow from via a margin loan? Or more preferably, grow the account to a point where you can just sell off some shares when needed, instead of taking a loan? 

The answer is that you probably should. 

The projected returns are higher. You get more control over your investments. The interest rates on borrowing via margin loans will be comparable. Yes, you sacrifice the modest tax deferral benefit of policy cash value growth, but you gain much more flexibility with your money over the years. 

Downside #2: High Costs

When utilizing a taxable brokerage account, 100% (or close to 100%) of the money you invest actually gets invested. You’re then charged an annual fee for that investment. As a reference point, Vanguard’s VOO S&P 500 ETF has an annual fee of 0.03%. 

When investing through a life insurance policy, several fees are added even before your money is invested. 

Of course, there’s the cost of the insurance itself. However, additional fees include administrative fees, marketing fees, agent commissions, investment management, and insurer profits. 

This is akin to paying an upfront load on an investment. 

The exact expense ratio costs on cash value growth are opaque and nowhere near as transparent as index funds’ straightforward percentage of assets disclosure. Teasing apart all the layers of fees is virtually impossible. But suffice to say, they greatly exceed mainstream index fund costs.

So, not only are you investing in a lower-yield asset, you’re paying more to do so. 

Downside #3: Risk of Policy Lapse

Whole life insurance policies require annual premium payments. 

In the early years of an infinite banking strategy, payments also need to be overfunded. In later years, many people end up using the cash value of the policy to pay down the premium, instead of making another large payment.

This requires a lot of things to go right. 

You have to not only have the cash flow in Year 1 to make the strategy work, but also know that you’ll have the funds to make the required premium payments in Years 2, 6, 10, and so on.

Businesses fail. There’s divorce. There are job losses. Many things can change financially over time, causing you to fall short of the cash needed to fund the policy.  

In many cases, when someone can’t pay the needed premiums, they have no choice but to surrender the policy, which means canceling it and receiving the surrender value (the remaining cash value minus any surrender charges and outstanding loans).

The problem here is that life insurance policies typically have high surrender charges. A common structure is a 10% charge in the first year, decreasing by 1% annually. So, if you surrender in year five, you might face a 5% charge.

According to one study, about 3% of whole life policies lapse each year. While that doesn’t seem that bad, that’s looking at all policies in force each year. That means over the long-term, the probabilities become:

It’s important to keep in mind that in most cases, it’s only after about 10 years (and with overpayments) that there starts to become a significant cash value to borrow from.

25% of people who buy a whole life policy never make it to that point. 

Surrendering a life insurance policy can also leave you without necessary coverage later in life when you may need it most. 

If you need life insurance again in the future, purchasing a new policy can be more expensive, as premiums generally increase with age. Additionally, your health status may have changed since you bought the policy, potentially making qualifying for new coverage more difficult or more costly. You might face higher premiums or even be denied coverage.

In hindsight, you may wish you had initially purchased a more affordable term life insurance policy instead of the more expensive cash value policy.

Downside #4: It’s Still Debt

If you have the spare cash to fund one of these expensive policies in the first place, you likely have simpler and cheaper ways to cover big expenses down the road. 

Sure, borrowing from a policy might beat borrowing from a credit card or taking out a personal loan. But for those with strong finances, options like credit cards with 0% interest, auto company financing deals, HELOCs, or loans using investment accounts as collateral can match or beat those rates. 

All without having to prepay years of insurance premiums.

If you’re able to afford large policy premiums year after year, more straightforward options, like saving or taking good financing deals when available, put more money in your pocket. There’s no need to twist insurance into a bank replacement.

Final Thoughts on Infinite Banking

Rather than using complex whole-life strategies for banking purposes, there’s a more straightforward and more effective approach that provides similar benefits. 

And all the while, you have the chance to grow your money at a much faster rate:

1. Buy term life insurance. Inexpensive term life insurance can provide more than adequate death benefit protection at a fraction of the cost of cash value policies. I ran a quote for a healthy 30-year-old on a 20-year term, and it came out to $30 per month. 
2. Invest savings in a taxable brokerage account. By choosing low-cost diversified index funds, your money can grow at stock market rates over time.
3. If needed, sell a portion of your investments. Since your balance will likely be much higher in the long run by investing more aggressively, you can simply sell a portion of your investments to access funds when needed. This approach allows you to avoid going into debt while still having access to your money. If you’re not looking to incur the taxes, take out a margin loan. 

This approach allows for greater flexibility in good times and in bad. 

You avoid the high surrender charges and tax headaches that come from lapsing or borrowing against cash value policies. And by investing based on your risk tolerance, expected returns can significantly outpace most whole-life insurance policy rates.

Overall, there’s simply too high of a failure rate when you look at how many whole-life policies stay in force.

With far simpler and more effective options available to meet your needs, infinite banking seems an unnecessary gamble rather than a prudent approach.

R.J. Weiss

R.J. Weiss, founder of The Ways To Wealth, has been a CERTIFIED FINANCIAL PLANNER™ since 2010. Holding a B.A. in finance and having completed the CFP® certification curriculum at The American College, R.J. combines formal education with a deep commitment to providing unbiased financial insights. Recognized as a trusted authority in the financial realm, his expertise is highlighted in major publications like Business Insider, New York Times, and Forbes.