Infinite banking explained: Is this popular TikTok financial trend worth the hype?

With the rise of TikTok as an information-sharing platform, financial advice and strategies have found a novel way of spreading. 

One such strategy that has been making the rounds is the infinite banking concept, or IBC for short, garnering endorsements from celebrities like rapper Waka Flocka Flame. However, while the method is currently popular, its roots trace back to the 1980s when economist Nelson Nash introduced it to the world.

Despite the buzz, the complexities and risks associated with infinite banking might outweigh the advantages for the average individual. Here, we delve deep into the workings, legitimacy, and suitability of infinite banking.

What is infinite banking?

In essence, infinite banking is a method of recycling cash flow through a whole life insurance policy to perpetually compound these funds, even when borrowed. This approach aims to achieve the following:

• Built-in tax-sheltering
• Steady growth decoupled from market fluctuations
• Protective benefits like death, disability, and potential lawsuit coverage
• Continuous compounding of your cash value during borrowing

How does infinite banking work?

Central to understanding infinite banking is distinguishing it from life insurance. The strategy hinges on whole life policies, which contain a cash value component and are long-term in nature.

Within these policies, the cash value grows based on a rate set by the insurer. Once a significant cash value accumulates, policyholders can obtain a cash value loan. These loans differ from conventional ones, with life insurance serving as collateral, meaning one could lose their coverage if borrowing excessively without adequate cash value to support the insurance costs.

Non-repayment of loans might also reduce the ultimate death benefit. And while the allure of these policies is evident, there are innate limitations and risks, necessitating diligent cash value monitoring.

Is infinite banking legitimate?

The strategy’s legitimacy isn’t black and white. For high-net-worth individuals or business owners, especially those using strategies like company-owned life insurance (COLI), the benefits of tax breaks and compound growth could be appealing. 

On the flip side, the inherent risks make it an unsuitable choice for most people, emphasizing the need for expert financial consultation before diving in.

Not everyone’s cup of tea

The allure of infinite banking doesn’t negate its challenges:

• Cost: The foundational requirement, a permanent life insurance policy, is pricier than its term counterparts.
• Eligibility: Not everyone qualifies for whole life insurance due to rigorous underwriting processes that can exclude those with specific health or lifestyle conditions.
• Complexity and risk: The intricate nature of IBC, coupled with its risks, may deter many, especially when simpler and less risky options are available.

Risks of infinite banking

Here are the main risks to consider regarding the IBC:

• Reduced death benefits if borrowing without maintaining premiums
• Complete loss of policy and investments if premiums lapse
• Unmet investment return expectations 

Given these risks, especially when your family’s financial protection is at stake, consulting with a financial advisor is crucial.

Pros and cons of infinite banking

PROS

Tax benefits

Cash value in permanent life insurance policies grows tax-free, and loans against that value are not taxed. Life insurance payouts to beneficiaries are also tax-free.

Guaranteed returns

Unlike other permanent policies, whole life policies have fixed cash value growth rates set by the insurer. If your policy is with a mutual life insurer, you may also earn annual dividends based on the company’s performance.

Cash value policies can make it easier to get a loan

Traditional lenders require loan applications, credit checks, and set repayment dates for personal loans. In contrast, policyholders with whole life policies can borrow against the cash value without explanations or credit score requirements once it has accumulated enough value. This liquidity improves cash flow and helps policyholders cover unexpected expenses like medical bills.

Repayment flexibility 

You don’t need to pay back a cash value loan by a specific date — or at all (if you’re not concerned about maintaining your life insurance coverage). This might be appealing if you want to repay a loan at your own pace.

CONS

Whole life insurance is pricey

Whole life insurance tends to come with a hefty price tag due to its cash value feature and guarantee of lifelong coverage.

For example, a healthy 40-year-old man can expect to pay around $7,000 annually for a half-million dollar whole life policy (about a thousand less for a woman). Committing to infinite banking requires paying high long-term premiums. 

In comparison, a 40-year-old man in excellent health would pay about $330 per year for a 20-year, $500,000 term life insurance policy. A woman could pay around $280 — significantly less than whole life insurance.

Cash value builds slowly 

Cash value growth takes time, requiring years to accumulate enough for a loan without added fees. Unless you have ample discretionary funds, infinite banking isn’t a fast track to wealth creation. Whole life insurance primarily aims to provide a death benefit, not serve as an investment.

Policy overfunding takes a lot of cash

To make infinite banking work, you’ll need to contribute a substantial amount of money to your policy’s cash value. Allocating around 10% of your monthly income to the policy is just not feasible for most people.

It’s really confusing

Utilizing life insurance as an investment and liquidity source requires discipline and monitoring of policy cash value. Consult a financial advisor to determine if infinite banking aligns with your priorities.

What to know before jumping into IBC

Part of what you read below is simply a reiteration of what has already been said above. But there’s a reason for that: it’s important. So before you get yourself into a situation you’re not prepared for, know the following first:

1. You’re not really acting as your own bank

Although the concept is commonly sold as such, you’re not actually taking a loan from yourself. If that were the case, you wouldn’t have to repay it. Instead, you’re borrowing from the insurance company and have to repay it with interest. Of course, you can choose not to pay it back, but your cash value will have to pay for your premiums, and you risk lapsing your policy.

2. There are expenses you have to pay

Some social media posts recommend using cash value from whole life insurance to pay down credit card debt. The idea is that when you repay the loan with interest, the amount will be sent back to your investments.

Unfortunately, that’s not how it works. When you pay back the loan, a portion of that interest goes to the insurance company. Prior to borrowing from your policy, some of your premiums pay for expensive commissions and fees and are not credited to your cash value.

3. Paying for an exorbitant policy doesn’t actually generate any additional returns 

Receiving dividends from a cash value life insurance policy may sound nice, but those dividends are essentially a return of your premium payments. For example, if you overfund a dividend-paying policy, your excess payments are returned to you as dividends.

4. You must deposit a substantial amount of money into your account before you can start drawing from it

Unless you have a few million dollars to dump into a whole life policy right now, it’s impossible to “be your own bank” overnight.

Before borrowing against your policy, you must accumulate a substantial cash value, which takes time. For the first several years, you’ll be paying off the commission. This makes it extremely difficult for your policy to accumulate value during this time.

5. Most people can’t afford a big, fat whole life policy

Whole life insurance costs 5 to 15 times more than term insurance. Most people simply can’t afford it.

So, unless you can afford to pay a few to several hundred dollars for the next decade or more, IBC won’t work for you. The reason comes down to keeping your policy active: if you can’t pay the premiums, your policy will lapse (terminate).

Alternative options to infinite banking

Not everyone should rely solely on themselves for financial security. If you require life insurance, here are some valuable tips to consider:

• Consider term life insurance. These policies provide coverage during years with significant financial obligations, like mortgages, student loans, or when caring for young children. Make sure to shop around for the best rate.
• Contribute money to other tax-advantaged accounts. If you choose term life insurance over whole life, consider investing the saved premiums in your 401(k) or Roth IRA. These accounts can fund your retirement while maintaining life insurance coverage as long as necessary for you and your family.
• Prioritize building an emergency fund. It’s important to have an emergency fund before considering an infinite banking strategy. Start by opening a high-yield savings account and aim to save enough to cover three to six months of living expenses. 

Final word

While infinite banking offers an alternative financial strategy, it’s crucial to approach it with caution. Always remember that every financial move should align with your specific needs and risk tolerance. As always, seek the advice of a trusted financial professional to guide your decisions. 

And if you prefer more traditional investments, there are plenty of avenues to maximize your capital. Either way, make sure the cost and risk of any strategy are worth the financial security it provides in the years ahead. 

Above all else, don’t let social media hype cloud your judgment or go against what’s best for your family long-term. Your financial future should be met with careful planning and measured risk. Taking the time to become educated about all available options is essential in creating a secure financial future for you and your family.