Throughout our lives, many of us will end up paying a large amount of money in interest to creditors and financial institutions. Whether it’s student loans, personal loans, mortgages, credit cards, or auto loans, the amount of money that many of us pay is significant. In 2020, the average consumer had $ 92,727 in debt according to Experian, the credit bureau.
Cash flow banking, also called infinite banking, is designed to circumvent this conventional path to institutional debt, mitigating your dependence on banks and reducing the amount of interest you pay. The concept is simple: when you need money, you borrow it from yourself, or rather your own insurance policy.
Sounds good? While cash flow banking can have great appeal, it is generally an impractical strategy for anyone except the wealthiest. It is a long-term game that requires significant expenses early in life to reap the benefits later. Read on to learn more about what cash flow banking is, how it works, and if it is a scam.
What is cash flow banking?
In the 1980s, an insurance agent named Nelson Nash developed a financial strategy that reduced clients’ reliance on high-interest loans from traditional banking institutions. In his book, “Becoming Your Own Banker,” Nash encouraged readers to purchase a life insurance policy and borrow when necessary. His strategy became known as the cash flow banking method.
Again, the concept is simple. First, you get a low-interest loan from a mutual insurance company. Then when you need money, use your accumulated funds. Instead of paying a high rate of interest to a lender, you take advantage of the low interest rate on your policy and pay yourself, and whoever eventually inherits the proceeds from your life insurance policy.
What type of life insurance policy is required for cash flow banking?
There are many types of life insurance, but two of the best known are whole life and term. Most people have term life insurance, which is cheaper and covers you for a set period of time.
Read more: The best life insurance companies
Whole life insurance is significantly more expensive. According to PolicyGenius, the medium term life insurance premium It costs between $ 20 and 30 per month or between $ 240 and $ 360 per year. Whole life insurance covers you for your entire life, so you don’t have to worry about outliving your policy. As compensation, you pay higher premiums: average whole life insurance premiumOn the other hand, it costs between $ 55 and $ 136 per month or $ 660 and $ 1,632 per year.
The cash flow banking strategy is based on whole life insurance, because you can borrow with that type of policy.
How does cash flow banking work?
The first step is to purchase a comprehensive life insurance policy. You will then have to wait a while, such as several decades, for your policy to increase in value. Ultimately, when you need a loan, you can request it against your policy instead of a loan guaranteed by a traditional lender. Although you are technically borrowing against your own policy, the money you borrow comes from a General fund within your life insurance company. Whenever you get a policy loan, your whole life insurance policy will serve as collateral.
Keep in mind that it can take years to build up significant enough cash value to borrow funds. If you’re hoping to get a big loan, it may take decades. As such, cash flow banking for a down payment on a home won’t work for everyone. You’ll get the most value for decades to come, if you can keep up with the high monthly premiums.
Considerations when choosing a whole life insurance policy
A whole life insurance policy is the foundation of cash flow banking, and setting up your policy correctly is key. First, you’ll want to look for a policy that offers dividends, which are payments of the insurance company’s earnings to its policyholders. Dividends can be distributed annually, but are not guaranteed. Ideally, you can end up paying your premiums, or at least a portion of them, with the dividends you earn each year.
Another important factor is the additional insurance paid. Paid additions are optional coverage “boosters” that can increase the cash value of your life insurance policy and generate higher dividends (and interest). The additional insurance paid is generally purchased with dividend earnings rather than a higher premium.
Bank cash flow tax incentives
There are some. With a whole life insurance policy, the death benefit is paid tax-free to the heirs of your estate. And dividends from a life insurance policy are also tax-free, which means there are no taxes on loans or withdrawals made from your policy or appreciations in its value.
Is Cash Flow Banking A Scam?
No. It is an esoteric strategy, albeit a valid one, that requires an amount of resources, investment and patience that is beyond the reach of most people.
Advantages of cash flow banking
Here are some reasons why cash flow could be beneficial:
- Low interest rates: Insurance companies generally charge lower interest rates than traditional lenders and credit card providers.
- Dividends may not decrease after borrowing: Most banks and financial institutions use “direct recognition” when they pay interest on their savings; that is, they pay interest only on the cash in your account. When you withdraw $ 10,000 from a $ 30,000 account, for example, you will only earn interest on the remaining $ 20,000. However, some insurance companies will pay you the same dividend, even if you have borrowed against your policy. In that case, you would continue to earn dividends on the entire $ 30,000.
- Quick access to cash: Since you will be borrowing funds from your own insurance policy, you can quickly get cash when you need it, without the need for an application to be approved and processed.
- Fiscal benefits: Life insurance policy funds are tax-free.
- Flexible loan terms: If you cannot repay the loan, the loan balance and interest are subtracted from your policy, a much better alternative to defaulting on a conventional loan.
Disadvantages of cash flow banking
Cash flow banking may be an effective strategy for some, but for most of us, it is not a practical way to manage our money or finance major purchases. Here are some disadvantages of the method:
- Dividends are not guaranteed: Although mutual insurance dividends tend to be quite reliable, they are not guaranteed. If dividend payments are part of your cash flow banking strategy, it is a risk.
- Premiums are expensive: Whole life insurance policy premiums cost significantly more than term life insurance. And if you miss a single payment, you risk losing your policy. For this reason alone, cash flow banking can be risky for anyone who is not entirely sure that they can comfortably afford long-term premiums.
- Life insurance policy funds take time to build. Before borrowing, you will need to extend your policy. This could take decades. And if you need a loan before you accumulate value, it could upset your entire strategy.
Is Cash Flow Banking Right For Me?
Cash flow banking may be a stretch for most of us. But if you can afford the high premiums and understand the risks involved, you can provide flexible, interest-free liquidity. With that said, if you can’t afford a whole life insurance policy,it’s a worthwhile investment that can offer financial protection for you and your family.
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