Coincidentally, we received several emails asking about a concept called “be your own banker”. This has been around for decades, but apparently is now being remarketed as “Infinite Banking”, “Bottomless Banking” among other catchy names. Why pay interest to a bank when you can enjoy the “extraordinary benefits of creating your own banking system”? One site claims the method will “make you rich”. Does it sound too good to be true? Sound like a scam? Read on.

The idea works like this: open a whole life insurance policy and fund it as much as you can. Then when you need to borrow money, borrow it from the policy tax free and pay the interest back into the policy which is really to yourself. (Of course, you must firt have the money you want to borrow, which sort of defeats the purpose of borrowing anyway, but there’s more.) The benefits include the fact that you get life insurance coverage, the interest you earn from paying yourself accumulates tax-free, terms of the loan are up to you and available anytime. Is it a scam? Well, if your skeptical alarms start going off, good for you because it certainly sounds like a scam. However there is a bit of legitimacy to it, yet it doesn’t necessarily live up to the promises either. As usual, the devil is in the details.

A term life policy is basically nothing but pure insurance on your life for a set period or term. With term life, there is no accumulation, no loans, and no bells and whistles- it simply pays if you die within the term. A common form might be to insure a healthy person for $500,000 for 20 years at a cost of $600 per year. Die within those 20 years and your heirs get $500,000 provided you paid the premium. Die in year 21 and they get zip. Whole life on the other hand, does not have a term. As long as the policy is “current”, it will pay when you die whether that is at age 40 or 95.

A feature of whole life insurance (WL) is that it “accumulates” something called “cash value”. In essence, you put money into the policy determined on an actuarial basis to accumulate to the face value by a certain age. For example, you may contribute to a $100,000 WL policy enough so that the policy will have accumulated $100,000 in contributions and earnings by age 95 (it varies by policy; sometimes it is 105). Since that accumulation is the policy owner’s asset, the owner is allowed to borrow from it provided it gets paid back to the policy. Since it is a loan, there are no taxes on the proceeds. Since the earnings in the policy (including interest you pay on the loan) are part of life insurance, they are not taxed as income unless you cash out the policy. (This is where the tax-freeness comes from.)

So with be-your-own-banker, you borrow from yourself accumulating the interest tax free. Obviously there is a catch. The first hurdle is that every policy has multiple fees built into it. One fee is called the “mortality charge” which is the actuarial cost to insure your life. Think of it as the cost of term insurance- the pure cost to protect against early death, only the policy pays at any age so the mortality charge is much higher than with term insurance which expires. The second hurdle is that WL policies have other fees built into the policy like admin costs which essentially amount to profits for the insurance company. Total fees are usually higher in the early years of the policy too because the insurer has to recoup sales costs. All of these fees and costs mean that the policy will take 7-10 years typically to “break even”. That is, it takes 7-10 years of payments before the earnings on the accumulated cash value are large enough to pay the premium so you don’t have to. Think of it like a bank account- it has to have a large enough balance to earn enough interest to pay some bills.

Instead of making up numbers for the sake of this article, I have asked an insurance broker I know to provide a quote for a plain-vanilla $100,000 whole life policy on a 40-year old healthy non-smoking male. This policy has a fixed annual premium of $887. Such policies provide projections or “illustrations” estimating future performance. This particular policy accumulates cash value of $7,070 in year 10 at current rates (read: not reliable) of 4.7% and just $4,500 at the guaranteed minimum returns promised. A little quick math shows that $887 invested at 4.7% each year will compound to $11,001 in ten years. But what about the $100k of insurance coverage you get in addition to the cash value? Well, a 30-year term life policy for $100k might cost around $150 per year, so compounding $737 instead of $887 gets you $9,141- still far outpacing the policy. At this rate, it is going to take a long time to have enough in the policy to buy a car. In fact, it will take until year 22 to have $20,000 available.

Let’s say we accelerate this process and put $5,000 per year into the policy in addition to the $887 premium. I backed into the mortality charges and so was able to calculate a cash value of $24,000 after year 4. Now, we can borrow $20,000 from ourselves via the policy to buy a car and “be our own banker”. Recall that we have to pay the money back, with interest, to the policy. Assuming a 6% rate and a 5 year “loan” to ourselves, we pay $4748 for 5 years plus the regular $887 premium.

At the end of year 9, the loan is paid back and our policy is worth $35,283, which doesn’t seem so bad or is it? Remember, we paid $5,887 into the policy for 4 years, then $5,527 for another five years. This works out to a negative 9.5% annual return! Total paid in: $51,183; ending value: 35,283.

Perhaps most surprisingly, this compares ok with the “traditional” way of doing things: Term life for $150, invest the $5,737 at the same 4.7% for the first four years, then take a traditional loan for the $20,000 at 6% (while the first four years continues to compound). When all is said and done, you end up paying or saving $47,288 and having $32,428. The annual return on the traditional program works out to -9.2% annually- slightly better than the be your own banker system. So who is getting rich with such programs? You guessed it, the insurance salesperson.