- Personal Finance»
Bank on Yourself Whole Life Insurance Strategy Review and Opinion
Bank on Yourself - Legitimate Investment Method or Scam?
The book "Bank on Yourself" written by Pamela Yellen describes a very hyped and controversial method for individuals to create wealth. She claims banks and the investment industry do not want consumers to know about this wealth creating product because it allows consumers to forgo their very profitable services and make money while "borrowing" from themselves. The product touted so highly in the book is non-direct participation whole life insurance with paid-up addition riders issued by various mutual life insurance companies.
Does "Bank on Yourself" really allows those who implement it to "get back every penny" they spend over their life while growing wealth better than the unpredictable volatility of the stock market? Or, is "Bank on Yourself" a perverted scheme to get unsuspecting consumers to buy a financial product that few people "need" because it is far too expensive when compared to the alternative of buying term life insurance and investing the difference in more effective and less expensive way like many fee-based fiduciary financial planners and television financial advisors like Dave Ramsey and Suze Orman recommend?
The purpose of this article is to separate fact from fiction surrounding the financial industry and "Bank on Yourself." Consumers will understand how the banking system works, where the money is made and whether or not the product behind "Bank on Yourself" will make their financial life safer, simpler and more abundant as the book promises, or if it is a waste of time and money that they will regret if they bought this system.
What the Bank on Yourself Method Promises Consumers
I read two books by Pam Yellen - "Bank on Yourself" (2009) and "The Bank on Yourself Revolution" (2014). These books describe the reasoning for a person to implement the bank on yourself method into their lives. I have also talked to a number of life insurance agents who promote this method of building wealth. The argument that "Bank on Yourself" makes is compelling and the books and the agents promise a way to:
- "Spend and Grow Wealthy" by placing a majority of their money into cash value whole life insurance.
- Borrow from the cash value of these policies which will eliminate the need to deal with banks ever again as life insurance policy becomes "a bank."
- Recapture the cost of borrowing because when an individual repays the loans from the life insurance policy, he or she is actually placing the interest back into their own personal accounts.
- With this system the individual is able to recapture all the costs of buying cars, going on vacations and sending their children to college instead of sending the interest to the banks. They will be able to increase their net worth and can avoid the need to participate in the stock market to become wealthy and financially independent.
Can you really borrow from a life insurance policy, pay the loan back and make money doing so?
Margin Loans on Investment Portfolio's
If you own stocks, bonds, limited partnerships, TIPS or Business Development Companies in a brokerage account, you have the ability to borrow funds against the equity in the account. There aren't any rules or underwriting you have to go through to do this. All you have to do is set up the account and the brokerage firm will allow you to take money - no questions asked.
The interest that these companies charge are low AND tax deductible against earnings. For example, I have seen accounts where the interest rate to borrow against an investment portfolio of securities is only 1.5%.
Are life insurance loans a better concept than borrowing against an investment portfolio of stocks? Can an owner of a life insurance company create money out of thin air?
This would be wonderful concept, and would be a "financial secret that 'they' don't want you to know" because, if real, would severely decrease the profitability of actual banks and the financial industry when they lose customers they want to lend money to.
Unfortunately, Bank on Yourself isn't that good. This doesn't mean whole life insurance is a bad product though. One can't spend themselves wealthy is all.
Financial Planning Video
The Mechanics of a Bank on Yourself Participating Whole Life Insurance Policy
There are a lot of different types of life insurance policies on the market. In an effort to reduce confusion for now I am going to generalize these policies into two distinct types: Term Life Insurance and Permanent Life Insurance.
Term life insurance allows a policy owner to obtain the highest amount of "death insurance" for the least amount of premium. "Term" refers to a period of time.
For example, a 40 year old may want to have coverage of $1,000,000 that last until they are 60. In this case, they could buy a 20 year term life insurance policy and it might require them to pay about $70/month in premium.
If they are blessed enough to live through the term (which for a 40 year old is highly likely but not guaranteed), then the insurance company keeps the money paid into the policy and the proceeds are distributed to the beneficiaries of policy owners that died during that term and the life insurance company's owners.
Permanent life insurance is different. "Bank on Yourself" recommends that an investor use a certain type of permanent life insurance policy manufactured by a mutual life insurance company called a non-direct participating whole life policy.
I will break down the meaning of this term in three parts:
- Mutual Life Insurance Company
- Participating Whole Life
- Non-direct (vs. direct) Participating
Owning a company can be achieved a few different ways. One of the most understood ways of doing so is to invest in a company's stock.
When you buy the stock of a company, you become a partial owner of that company and are entitled to a portion of its earnings. For example, if you were to invest in (1) share of The Walt Disney Company, then you would own about .00000000059% of the company because there are 1.7 Billion shares outstanding. You would therefore be entitled to that percentage of the profit the company distributes. You would also have ability to profit from the increase in the price of the stock.
You may also lose money if your share of stock goes down in value but you will still receive your share of the profits.
You can invest your money into the stock of an insurance company as well. The profits the owners of the stock would be entitled to might come from the profits of the various life insurance policies these companies sell.
A person can not invest in mutual life insurance companies by buying their stock. Instead, the owners of a mutual life insurance company are their whole life policy holders. The mutual life insurance company then distributes the profits (surplus) to the whole life policy owners based on the amount of cash value they have in their policy.
Mutual Insurance = Owned by Policy Owners
Participating Whole Life is a whole life policy where the policy owner "participates" in the profits of the company. The profits of a mutual whole life insurance company can come from the money they make on their whole life insurance, their term life insurance and their other product lines. Some mutual life insurance companies have Wall Street Firms themselves known as "broker-dealers" and others even have actual banks and mutual funds where the profits they make are distributed to the owners of their participating whole life policies. However, most of the money that any insurance company makes comes from the way they invest their policy owner's premiums.
Insurance companies invest their premiums and the profits that their owners reinvest into the company through the use of what are known as a "Paid-up Additions" into a gigantic portfolio of fixed income securities. Insurance companies invest into bonds, mortgages and other forms of debts.
Non-Direct Participation Whole Life Insurance seems to be the key to making the "Bank on Yourself" concept work. Mutual life insurance companies whose policies are structured this way create the ability for a policy owner to borrow the money away from the policy but still receive the dividends from the profitability of the company! This is compared to Direct Participation Whole Life Insurance which will not pay dividends on money that has been borrowed from a policy by a policy owner.
This is one of the features of whole life that the author of "Bank on Yourself" and her advocates point to as the reason "you can get all of your money back when you spend and earn" so that "you can avoid Wall Street and real estate" investments that have caused people to go broke over the years.
Stocks can be volatile. They have been known to decrease in value by 50% from time to time. However, the stock market has averaged a return of 11.14% between 1984-2014 vs. the return of Whole Life of around 6.5% after the insurance costs are taken out.
To avoid the stock market and Wall Street altogether is a big mistake. If investors are worried about losing all their money in the stock market there are ways to invest and limit the amount of potential loss.
How Does Bank on Yourself Help a Person Make Money on Money They Spend?
How can a life insurance company make money out of thin air for their policy owners? The answer is they don’t but a non-direct participation whole life policy has created what is known as an arbitrage profit when a loan is taken against it over the last 35 years. The same is true of stocks in the stock market to though only this arbitrage is much bigger.
People buy stocks, bonds and whole life insurance. They are all assets. As long it costs lessto borrow against them than what they earn it can increase the amount an investor earns. This is the same premise of why people take out mortgages to buy a house. Do you think as many people would buy house with debt if they thought the loan would cost more than the house would increase in value? Of course not.
Problems with assets and loans are that growth of the asset is not guaranteed to be higher than the cost of a loan against it.
One benefit of Whole life is that it is contractually guaranteed to have a minimum rate of return. Any additional profits the company makes is returned to the policy owner in the form of a dividend which are not guaranteed.
Loans from a brokerage against stocks and bonds, loans against property and loans by insurance companies against life insurance policies are known as collateralized loans.
The difference with a life insurance loan and loans against stocks and bonds (known as margin loans) is that the interest charged against the accounts don't need to be paid back as long as there is enough equity in the account to offset the interest.
“Bank on Yourself” is not a scam but it is not magic either. The long term returns of whole life insurance should be close to the returns of a well diversified fixed income portfolio over time with the additional earnings added to it from the insurance company’s profits. As long as this return is higher than the lone interest rate, there will be an arbitrage profit.
The problem with loans against life insurance is that the interest charge is not tax deductible and are typically considerably higher than margin loans against investment portfolios.
Whole Life Insurance Does Have Its Place.
Whole Life Insurance does have its place. It just isn't to take loans against regularly under the pretense that by borrowing you are somehow creating wealth. This is just silly.
It is always best to use the cheapest money available to make purchases or take as income when retired. Rarely is Whole Life Insurance the best asset to do this with.
However, the fact that life insurance is contractually guaranteed to have a minimum rate or return as well as have the ability to earn dividends is an appealing attribute. In addition, whole life does have the insurance benefits and long term value that increases the longer it is held.
Learning how to use life insurance to generate an income with the stock market while also using the actual death benefit associated with it to protect others who rely on your income and preserve an estate is something few people discuss.
Instead they come up with strange marketing ploys like "Bank on Yourself" which advocates steering clear of the stock market all together.
Life insurance sales people tend to hate Wall Street and point out all it’s problems.
IOn the other hand, investment sales people tend to slam life insurance pointing out the amount of time it takes to break even and “anemic” gains when compared to stocks over the long term. They basically contradict themselves in their statements by look at life insurance in the short term and the stock market in the long term!
To be successful financially, an investor needs to be able to milk each financial industry for everything they are worth by extracting all the benefits they can provide while not over exposing themselves to the risks each one pose.
The book "Comfort Investing" begins to show investors how to participate in the upside of the stock market but use the strength of a Whole Life policy to protect themselves from losses.