This is the final article in the 5 part series of understanding what is Dividend Paying whole life insurance. I mentioned in our last article, all the great attributes that a whole life policy, properly structured, can do for you during your living years. Although there are a lot of benefits to this, I think it is just as important to expand on the negatives. There are 3 major negatives mentioned below:
1) Costs - the costs are extremely high, but they are hidden into the premium of the policy. There is a reason why there is a big difference the first 3 years between the cash value available and what you put in. The costs are administrative costs, agent commission costs, reserves for the death benefit, etc. The premium does not change as long as the policy is in effect, so one can see by the increase of cash value that this becomes more efficient over time. When compared to a mutual fund, where the expenses are disclosed up front, as the asset base grows over time in the mutual fund, your costs get larger with each passing year.
2) I know I have been simplifying things by saying the cash value is your cash, but it is not. The Cash Value is technically not your money, but the insurance company's. You have first access to the cash value and dividends accumulated, but you have paid an annual premium to leverage your savings, and in return, have a death benefit on top of the cash value. The reason I can say this is one can request a loan to get to the cash value. You don't loan to yourself, but an outside company does. You do have the ability to pay back the loan on your timeframe. How is the insurance company so confident that you will pay back the loan? There are 2 sure things in this life: Death and Taxes. Since we know the inevitable will happen to all of us, if there are any outstanding loans (which has a high collateral due to all the money put into the policy), the death benefit will be reduced accordingly to your heirs.
3) The marketing of infinite banking borders on deceptive. No one wants to talk about death, so this gets dressed up to sound like this cures all your financial ills. I'll cite two examples:
a. One is the concept of a net loan cost. If you take out a loan from the insurance company at 6% and you get credited on your cash value balance for 5%, the agent may tell you the net cost of the loan is 1%. That's garbage. The cost of the loan is the cost, no matter where you take a loan from. If you can get a car loan for 1.9% from a credit union, why would you want to pay 6%? The agent may say to you, if you have a variable cash flow, that even though you are paying 6%, you get to pay it back on your terms, that is a fair statement. What's also fair is no credit checks are done, and all you need to do is sign one piece of paper to get the loan started. However, if you are disciplined and pay your bills on time with no late fees, then always go with the cheapest loan option.
b. The second concept is paying more interest than on your stated loan. If you have been putting in the maximum allowed premium every year and take out a loan, the most you can pay is the loan plus the interest to the insurance company. That's it and nothing more. This is what Nelson Nash describes is a psychological trick. He says to pay all you can for 7 years and then you may start taking out loans. The dividends and cash value built up will help pay the premiums, and your loan you took out from the insurance company at 6% interest should be paid back at 10% interest. The best analogy I can give is the following:
You and your friend MEC decide to run a marathon together. You agree to run 10 minute miles for the first 7 miles. At the 7 mile mark, MEC keeps his 10 minute pace, but you decide to walk the next mile, which takes you 20 minutes. At 8 miles, you miss MEC (now at mile 9) and want to run alongside him again. The only way you can catch up is by running faster, so you begin to run 9 minute miles to try and catch MEC. By stopping your original pace (not paying premiums), you can "be the banker" and make up an interest rate to "pay yourself back" because the policy now has the cushion to do so.
Also, one must make the clear distinction between savings and investing. One who invests money is putting money at risk in the hopes of a greater return. Money that is in savings are dollars that you want to know will be there liquid and guaranteed without having the risk of the stock market or real estate market determining what the value should be at just the wrong time in your life. You have ultimate flexibility with the money, but to think you will compound this money at 10-12% a year is not what these policies are designed to do. I mentioned in the last article that the rate of return will be about 4.25% per year over 30 years, growing tax deferred and when structured properly, can be used for a tax-free retirement while still passing on a death benefit to your heirs**. (If you were in a 35% tax bracket, one would need to earn 6.5% before taxes each and every year for 30+ years to get the same final number.)
My final thoughts
So, how should one view an IB policy? First, it is life insurance and provides a death benefit to your heirs when you pass. Second, it is a way to leverage your savings account by having that death benefit to boot. Third, it gives very flexible terms in case you need a loan with interest rates and payback time. Fourth, it can assist in providing a tax-free retirement by taking out loans with no intention of paying them back (which will reduce the death benefit to the heirs). Lastly, if you look at this from an investment standpoint, be dedicated for at least 7 years to maximize the compounding effect of the cash value.
In terms of my overall portfolio, I am looking at this as a tax deferred bond with a variable bonus dividend and a death benefit kicker. It's there for diversification, and a hedge against the stock market with some very useful built-in bonuses. The death benefit that remains also passes on income-tax free (not estate tax free, though, depending upon the size of your estate, but there are ways around that). Please note, this is not my first line item for retirement, but more like my third or fourth. Please start with income greater than expenses, then a Roth IRA, then a 401[K] up to the match or equivalent for a small business owner, taxable investments, and then and only then, think about a whole life policy.
If you are interested in starting an IB policy, what should one look for in the insurance company? First, you want this company to be a mutual or a mutual holding company [MHC] and NOT a stock company. Mutuals and MHC are designed so that profits go back to the policy holders as excess dividends. MHCs have a majority shareholder, where the company could be converted into a public corporation. There are smaller companies, but the Big 3 Mutuals are New York Life, Mass Mutual and Northwestern Mutual. Metlife is an example of a stock company, hence one I would avoid, because the dividends go to the shareholders, not the policyholders.
Second, and I touched on it earlier, you want the cash value to grow as if you never took a loan out, even if you did. This is called non-direct recognition. The company pays the same dividend rate on the total cash value you have in the policy to all policyholders. If the company does direct recognition, they will traditionally have 2 dividend rates, one for the cash that stays with the company, and a lesser rate (possibly 0%) for the money that you have taken out as a loan.
Third, look for an insurance agent that understands the IB concept. Make sure they are licensed in your state to personally write the policy for you and not his or her boss, who is licensed in all 50 states and they feed every policy through them. Also, make sure that the policy follows at a minimum the 1:3 rule - the death benefit of the term life rider is at least 3 times higher than the death benefit of the base whole life policy. Ensure that at least 75% of the total premium you can put in every year is going towards the PUAs (the turbo) versus the base policy.
I encourage you to read the 3 forums listed below to really get much better insight into this. If you are skeptical, that's good. I was, too, and then I began to understand the benefits this specific structure of a whole life policy could provide. If it works within your budget, then be committed for a minimum of 7 years to fund this to its maximum. If it will make you broke trying, then start with term life insurance and switch over as your economic situation improves.
Books and forums on the Infinite Banking Concept with some Personal Reviews
Forum 1: Google: "Investorcentric.com and infinite banking"-about 70 posts
Forum 2: Google: "Enjoy Your Money Blog and infinite banking" - about 45 posts
Forum 3: Google: "Scam.com forum and Bank on Yourself" - the largest thread is 380 posts
Unfortunately, Kiplinger disbanded their forum, which was the best read of all of them
Becoming Your Own Banker: Unlock the Infinite Banking Concept by R. Nelson Nash - Read this 2nd (optional) and is the 3rd best book in the series. This is the granddaddy of the books and the originator on twisting Permanent Life Insurance to work for the living and not for when you are dead. The charts were accurate for the day, but those dividend rates are not even close in 2012. Still, you get more of the essence, but may still have a bunch of questions, and you can start poking holes in some of his thoughts.
A Path to Financial Peace of Mind by Dwayne Burnell - This one is the best book I have read on the subject of IB. It was written during recent times, so you have a much better sense of dividend compounding and the examples of how this policy can be used for an entire lifetime. There are still some voids in the complexity of the subject matter, but this one really is the best in laying the foundation. Of all the books I have read on the subject, this one would be worth the money to actually purchase and keep in your personal library if you are serious to pursue this design of policy.
How Privatized Banking Really Works by L. Carlos Lara and Robert P Murphy. Also found here:
- A very close 2nd best book on the subject, and if I call Burnell's book 1A, this is a solid 1B. One, because of the link, it's free to read. There are 3 sections - the first 2 go into real in-depth economics of Austrian banking versus American economics and how our economy is a house of cards. The real crux of IB is Section 3, and it fills in the gaps wonderfully of Burnell's book, really giving the depth of answering those last questions of how this works. No product is the perfect investment vehicle, but for safety and the process of saving (see the definition on page 78 vs investing), this has the potential to benefit multiple generations.