Saturday, August 28, 2010

Question for Financial Folks: Infinite Banking

I won't go into everything, but if you know what "Infinite Banking" is, I have a question: Is it really worth it?

See, our financial advisor is pushing it pretty hard, even had Nelson Nash come to pimp it. I've done a ton of research, and frankly, I don't get it. I mean, I completely understand the theory and the practice, but I really don't understand why people would choose it over a decent savings account or a low or 0% loan (while having the cash to pay it off). For example:

Example 1: Using CASH for purchase. $10000 account earning 5%.

I take out the $10000 and make purchase. It is no longer earning 5%. So, after 1 year, I have lost $500 in interest, correct? Well, lets say at the end of the year I put back the $10000 + $500 ($10500). So, it was as if I never took money out in the first place because I added $500 out of my pocket to make up for the lost interest. The opportunity cost of using the money was 5%, but I made it up by "charging myself" 5%. Following? Ok.

-This transaction cost $500 out-of-pocket and I have $10500.

Example 2: Commercial loan. $10000 at 5% interest.

I take a 5% loan from a bank and leave my $10000 in the bank, still earning 5% interest. At the end of the year, I pay off the loan in full for $10000 + an additional out pocket $500. My bank acoount earned $500, but the loan interest cost me $500. The opportunity cost of using this method was 0, but the interest cost of using this money was 5%.

-This transaction cost $500 out-of-pocket and I have $10500.

Example 3 (Infinite Banking): Policy loan for $10000, current loan rate 5%.

I take a 5% loan from my policy and make my $10000 of cash value collateral, still earning 5% interest + dividends. At the end of the year, I pay off the loan in full for $10000 plus an additional out of pocket $500 to free up my collateral. My cash value earned $500, but the loan interest cost me $500. The opportunity cost of using this money was 0, but the interest cost that I needed to pay free up my collateral was 5%.

-This transaction cost $500 out-of-pocket and I have $10500.

So why would I pay all the fees and whatnot for front-loading an IB system when I could do the first two options much easier? I know that IB technically has some tax shelter properties, but I'm thinking the HYOOOOGE fees in the startup kinda kill any tax advantages offered. What am I missing?


JDTapp said...

Quick note, will try and post more later. I teach this stuff and I'd never heard of Infinite Banking. Looking at the "official" website, I'm skeptical of anything that uses cash-value life insurance (which it appears this idea does). Whole life insurance is typically better for the person selling it than the insured (as you know).

The fact that it's marketed as a new and unique idea created by Nash who is an "economist" (of the Austrian school, red flag for me) also sits bad because I would expect to have seen it discussed on various economics and personal finance news outlets & blogs. So, doesn't pass smell test. Looking at endorsements of his book, I'm even more skeptical.

In your blog example, the person taking out the loan doesn't actually spend the loan, which shouldn't happen in real life. Is that how the system works, or is your example just hypothetical?

I'll do some digging later this week.

Greatmoose said...

Hi Justin! Good to hear from you. In my example, it's all hypothetical with easy numbers. Apparently, the idea has been around for over 150 years (used to be called "policy loans"), but Nash got ahold of it, and is pimping it like crazy. It's also called "Be Your Own Banker" and a few other names that escape me at the moment. Essentially you take loans from yourself out of a Whole Life Insurance policy and you have to pay yourself back with interest. It just seems very not worth it. Oh, the brokers get GIGANTIC returns from the insurance companies and your fees.

JDTapp said...

It seems like the point is to avoid banks, which is what the Austrian-school folks would like to do. But, you're not really "banking on yourself" you're banking on your insurance company instead. Insurance companies can fail (and if you have a huge over-funded policy you may not get the full value back from your state govt's guaranty fund). Banks can fail, but your deposits are insured up to $250,000.

It seems like it's marketed to people as a way to take out loans to buy cars, etc. You guys already understand the concept of saving/NOT borrowing to buy things, so I don't see the need.
One review I saw said: "Keep in mind that IB is not to be used as an investment tool, but rather a different way to finance purchases." If it's not an investment tool, why is your investment adviser pushing it?

You're paying premiums for that insurance policy, you pay fees to take out the loan. That seems to get left out of discussion on many websites.

JDTapp said...

And this link is probably the best explanation I found of how it works.

I'm quite skeptical about paying for a large whole life insurance policy (more coverage than you would need) in order to more easily finance purchases. I tend to go with Dave Ramsey's advice about life insurance-- buy term life until you have enough assets to be "self-insured."

Greatmoose said...

Thanks so much for the responses, J! That helps a lot. Pretty much what I thought, but I really felt like I was missing something. Guess not. I'm pretty irritated that this is getting pushed so hard, especially when our advisor knows we're Ramsey-ites. I really want to think the best about the guy, but I'm starting to wonder...