4 reasons the bank on yourself insurance concept stinks

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The bank on yourself concept isn't all it's cracked up to be!
The bank on yourself insurance concept uses whole life insurance to fund policy loans.

Every once in a while I get this “bank on yourself” concept creeping out of the woodworks. Usually it’s from one of my long-time clients, sometimes from a colleague or local professional. Everyone’s always looking for the “silver bullet” to end their financial worries after all.

The “bank on yourself” story goes something like this: use your life insurance cash values as a bank. Why not be your own bank after all? You can earn interest which you “pay to yourself”. You can borrow from yourself too! And if you are your own bank, your credit score doesn’t matter!

It all sounds really great. I’ll admit, before I researched it it sounded great to me too!

The fact is the bank on yourself concept is nothing more than buying whole life insurance and taking policy loans. The way it’s marketed it sounds so glamorous and financially beneficial. Unfortunately there are many things about the bank on yourself concept which investors simply don’t understand.

 

How does “bank on yourself” work?

The concept is pretty simple and it really does sound great! In fact, it sounds SO GREAT I even considered it for myself as part of my retirement plan. But every time I researched the bank on yourself concept, I found nothing promising. There are plenty of negatives however.

The bank on yourself concept works like this:

  1. Buy a whole life insurance policy on yourself
  2. Fund the insurance cash value (heavily)
  3. Borrow from the cash value when you need a loan (like for a car)
  4. Pay the insurance policy back if and when you like

The key is you must buy a certain type of whole life insurance policy. The type of policy the bank on yourself concept uses is a “paid up additions insurance policy”.

 

What is a “paid up additions insurance policy”?

The bank on yourself concept isn't all it's cracked up to be!
The bank on yourself insurance concept uses whole life insurance to fund policy loans.

“Paid up additions” is a type of insurance rider for a normal whole life insurance policy. Simply put, you fund the heck out of your whole life policy early and often. The more you fund the more you can borrow from the cash values quicker.

Be careful however. If you fund the policy too much it becomes a MEC (modified endowment policy). If it becomes a modified endowment policy you may lose some – or all – of the tax benefits. I’m somewhat confident your insurance company will help you avoid that from happening however.

If you were to compare a whole life insurance policy with a paid up additions rider to one without, you’d find the former grows a higher cash value faster. Additionally, the one with the paid up additions rider will typically have a lower death benefit as well.

The policy without the rider will have a higher death benefit. It will also take longer to achieve the same cash value to borrow from than the one with the rider.

What’s the benefit of paid up addition whole life policies? You can borrow more money faster from the cash value for starters. Your cash values earn dividends which grow tax deferred as well. This is especially important if you’re in a higher tax bracket and haven’t taken full advantage of other retirement plans like the Roth IRA or even a health savings account.

You can even use the additional cash value to increase your life insurance coverage with no medical underwriting. This can be really helpful if your health has declined since originally purchasing the life insurance.

So the bank on yourself concept hinges on buying a whole life insurance policy with a paid up additions rider. You can borrow later from cash values and “become your own bank”. Seems like a pretty good deal on the surface.

 

So what’s wrong with banking on yourself?

It sounds OK so far right? Pummel a bunch of money into a whole life insurance policy, get a death benefit, then borrow your own money. Wouldn’t you rather borrow money from yourself?

In the interest of full disclosure I’m a “buy term insurance and invest the rest into retirement accounts” kind of investor. I’m definitely NOT a fan of most insurance and annuity products. That being said, if I found an amazing insurance solution I’d certainly be all ears!

Unfortunately this isn’t the amazing solution I’ve been looking for. There are definitely some problems with the bank on yourself concept:

  1. You pay interest expense to borrow money from... yourself . That’s right, you actually pay the insurance company to borrow your own money! The insurance company does in fact pay you interest on your cash value, but you could borrow from your bank account without paying interest anyway. This is a wash (maybe).
  2. Loads and commissions. You pay the insurance broker a commission to sell the policy to you. Don’t fool yourself, you pay it even if you don’t see it! This reduces your cash value substantially early in the life of the insurance policy. It takes years to make up for the drop in cash value your policy loses in order for the insurance company to pay the brokers commission.
  3. Loan interest rate versus your interest crediting rate. The insurance company is in control of the rates credited and charged. You have nothing to say about it! If the interest you pay on your loan is 5% and the policy is paying dividends of 5% then it’s a wash. Remember they control the shell game! It would be simple for them to credit 4% and charge 6% and next thing you know your cash values plummet!
  4. Lifelong commitment. Once you’re into one of these insurance policies, you’re in for life! Insurance premium payments are required to keep the policy in force. You must make the premium payments regardless what financial situation you’re in. If for some reason you can’t make the payments, any loans you have outstanding become TAXABLE! Granted, you have a cost basis in the policy from you premium payments, but any growth you’ve withdrawn is taxable.

 

There are better ways to save and invest

Greed Stockbroker CommissionThere’s just not much of a reason to invest into this “bank on yourself” concept. It sounds so great when the insurance guy or gal presents it – you become your own bank. Heck – who wouldn’t want to be their own bank?

The fact is most people will borrow from these policies to fund an expensive goal like a car. They’ll end up paying the money back to the policy HOPING that the interest credited is a wash with the interest charged. Unfortunately research shows you’re likely to pay a spread.

Paying a spread means there’s a gap in the interest you’re paying versus the interest credit you’re getting. Basically you’re paying more interest than the insurance policy is crediting you. Many times the spread is .50% to .75%. That half a point to three quarters of a point really adds up over time!

Another reason bank on yourself sounds so great is brokers pitch them as a “tax-free retirement income vehicle”. Because bank on yourself investors can borrow their own money from their life policy cash value it is tax free.

This doesn’t work out in reality however. Bank on yourself investors must pay the borrowed money back or hope that the interest charged is less than or equal to the interest credited. While it is technically tax free, you need to pay the policy loans back or risk your policy values being eaten up over time.

Finally, consider your investment options. If you’re saving for retirement income, why not max out your retirement accounts. More specifically, invest in your Roth IRA’s. Roth IRA’s help you create a truly tax free retirement plan!

 

Bank on yourself in summary

I’m not a fan of banking on yourself. Don’t take it from me however. There are plenty of great articles on the concept like this and this. I’m not the only one who went looking for a financial “silver bullet” and came up empty.

I’ve researched this topic too many times. I always hope to come to a different conclusion. As I mentioned, who wouldn’t want to be their own bank?

There simply isn’t a silver bullet out there. They don’t exist. If you think they do, please send the concept my way so I can debunk it… or invest in it myself!

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4 COMMENTS

  1. While I’m not a fan of Bank on Yourself, the concept itself is solid. Whole life is not the only product that can be used to accomplish this strategy, but it does typically work the best. I agree that people need to max out their 401k plans, their Roth IRA, if they can income wise, before considering a strategy like this. And I’m assuming you’re not a fan of these concepts or annuity products because they are commission based products that “tie-up” funds, which you can not charge your fee on, correct?

    • Not exactly. I’m not a fan of commission based products because of the conflict of interest the financial advisors selling them have. If your doctor was paid a commission by pfizer to recommend their drugs, you’d question why all the prescriptions are pfizer drugs right?

      The amount of clients who bring us variable universal life policies, indexed annuities, guaranteed minimum withdrawal benefit annuities etc. is staggering. Not one client has been able to articulate how these products work for them.

      We’re in a sad state of retirement planning. Brokers are hocking these products and the clients don’t even understand how they work. They NEVER understand the fees, and they’re often shocked when I explain it to them. It’s heartbreaking, and often sets them back years in their planning.

      As far as our advisory fees, we charge a flat fee which covers planning and guidance on assets like insurance or 401k plans which we can’t manage directly. In a sense, we still get paid as consultants even if clients bring us these products where another advisor already made a fat commission.

      We’ve got multiple clients who have longstanding fixed annuities. We actually recommend they send money from their bond allocation to those annuities which in some cases are paying 4.5%. As a fiduciary, we’re just concerned with the client results, even if it means we earn less. So our compensation has nothing to do with the fact that most insurance products are not good options.

      Generally speaking, there’s no reason to own whole life insurance. Layering term policies throughout critical stages of financial vulnerability is far more prudent for the overwhelming majority of people.

      Great comment and question Anthony, I appreciate it! Best wishes! Greg

    • Great question! You take your principal contributions FIRST (assuming you’re taking retirement income), then it’s a loan on the policy.

      If you’re interested, I have an amazing no commission VUL policy I’m getting from TIAA. Reach out to TIAA and check into it.

      Brokers HATE this post because they don’t make the big payday.

      Check out http://www.wealthsummit.com! You’ll see what a good performing policy does relative to the “typical broker sold” policy.

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