Bank on Yourself Whole Life Insurance Strategy Explained
Is "Bank on Yourself" a Legitimate Investment Method or Scam?
The purpose of this article is to discuss whether or not a person can actually create wealth for themselves by borrowing from their whole life insurance policy to make purchases and paying themselves interest instead of to a bank. "Bank On Yourself" states that the ability to create wealth by borrowing from oneself is a "secret benefit" of owning whole life insurance that banks don't want anyone to know about.
Everyone is looking for a "secret formula" for easily building wealth. If one can really spend money and become wealthy then "Bank On Yourself" would be something mainstream! Then again, if "Bank On Youself" is an exaggeration of what whole life insurance contract can do, then those over promises need to be exposed so more people don't make important financial decisions based on false information.
Since whole life insurance is the magical product pitched by "Bank On Yourself" insurance agents that allows you to spend your way to riches. Therefore, I will also dive deep into the product and how it works.
What the Bank on Yourself Method Promises Consumers
I have read two books by Pam Yellen - "Bank on Yourself" (2009) and "The Bank on Yourself Revolution" (2014). These books describe the concept of creating your own borrowing system through the use of cash value participating whole life insurance. I have talked to a number of life insurance agents who promote this method of building wealth and they claim the concept discussed in "Bank on Yourself" will allow an investor who embraces the concept 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 paying the interest back to themselves.
- 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?
This seems too good to be true! Let's take a look.
Margin Loans on Investment Portfolio's
If you are make money by borrowing from a whole life insurance policy, why couldn't you borrow money from your house or stock portfolio to do the same? The reason is that you can't get wealthy borrowing and using your own money to make purchases even if you are paying interest back to yourself and not an actual bank.
Comparing Margin Loans on Investment Portfolios Compared to Life Insurance Loans.
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 when borrowing against a policy's equity but not the equity of a stock portfolio?
The answer is "NO" unfortunately. In both cases you are borrowing your own money and the interest you are charged by both is interest that you could have saved or earned had you not used a loan.
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What is Direct Participating Whole Life Insurance?
The product that "Bank On Yourself" claims will allow someone to spend themselves to wealth is direct participating whole life insurance issued by a mutual life insurance company.
There are a several 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. However, if the insured passes away during the term period, then the death benefit proceeds are distributed to the policy beneficiaries.
Permanent life insurance also has a death benefit and is unique in that it is the only type of insurance that is guaranteed to have a claim if you keep it your entire life. Because death is a certainty for everyone, permanent life insurance builds equity over time.
"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 as well as the appreciation of the stock you own over time. Of course 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 to own a portion of it if you wish. When you do this, the profits you as the shareholder may recieve would come from the various life insurance policies these companies sell as well as the companies management to run a good company.
Mutual life insurance companies are different. An investor can't buy shares of their stock. Instead, the owners of a mutual life insurance company are their whole life policy owners. The mutual life insurance company distributes the ompanies profits (known as its 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.
I believe avoiding the stock market is a big mistake. Instead of avioding it, an investors who is worried about losing all their money in the stock market should use strategies to invest that limit the amount of potential loss.
Why Bank on Yourself Can't Help a Person Make Money on Money They Spend?
The Bank on Yourself concept can't help someone make money on the money they spend.
What non-direct participation whole life policy can do is create what is known as an arbitrage profit when a loan is taken against the value of the policy. Arbitrage profit in this case means if one borrows money at one interest rate against an asset but the asset earns continues to earn an interest rate that is higher than the interest paid, then there is an arbitrage.
Arbitrage isn't unique to whole life insurance though. The same arbitrage can be accomplished against the value of ones stocks in the stock market or on a piece of property like their home when the asset being borrowed against has a higher rate of return than the cost of borrowing against it's value.
People buy stocks, bonds and whole life insurance. They are all assets. As long it costs less to 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.
The problem with borrowing against the value of an asset is that the continued growth of the asset that is a higher rate than the cost of borrowing against it is not guaranteed.
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. These dividends are not guaranteed however.
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.
As a matter of fact, borrowing against the value of a whole life insurance policy may be the most expensive money you could borrow. This is because the interest one pays to the life insurance company for the loan against life insurance policy is that the is not tax deductible.
If borrowing money against the cash value of whole life insurance is your only option to get the money you need at some point in time then use it. However, if you can borrow money from a bank at a lower interest rate to buy a car or use cash sitting in a low interest checking account to go on vacation then use that money first and let the wealth sitting in your whole life insurance policy continue to earn a higher rate of return paid by the insurance company.
You are not able to borrow money and get rich paying yourself the interest that you would have earned if you had just left the money in the whole life policy's cash value. Unfortunately this is the central benefit discussed in "Bank On Yourself."
Whole Life Insurance Does Have Its Place.
Whole Life Insurance does have its place. It just isn't to take loans against the policy 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 when making a purchase or take as income when retired. The cash value of a whole life insurance could the best asset to do this with but it isn't always like the book "Bank On Yourself" suggests.
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.
To be successful financially, an investor needs to be able to have someone who understands how use all the financial tools that are available in order to make the best possible financial decision.
The primary benefit of whole life insurance is its ability to create a large pool of money at the death of a policy owner anytime the policy is in force. Whole life insurance does not expire as long as the policy premiums are paid.
It is wise to participate in a comprehensive planning process with a financial planner who has an understanding of how all the pieces of your financial life fit together. Investments, insurance, cash flow management, debts, taxes, retirement income sources, available benefits and estate planning are all considered during the planning process.
If you are looking for the answers that make your life simple, save you time and put you in the best position to succeed financially then do yourself a favor and find someone you trust that can take you through the process and give you insight that will change your life.
There are a number of reasons to own a cash value policy like whole life insurance. Becoming your own bank just isn't one of them.