If you listen to talk radio much, you may hear an advertisement for a book – a concept, really – called “Bank on Yourself.” And of course, you can go to the website and download a white paper (usually these are dry and poorly illustrated sales documents for people who fancy themselves too cool for a good-old fashioned brochure, but some are very good).
In a nutshell, the book’s author, Pamela Yellen, advocates using dividend-paying whole life insurance policies, designed with a small death benefit and funded right up to the “MEC limit” to build up cash value as quickly as possible. You then use the tax-free withdrawals and tax-free loans from the cash value in the whole life policy to supplement your retirement savings, or finance large purchases, such as college tuition and cars, using your policy (and paying yourself back – or not – the loan is secured by the death benefit, so it’s the safest loan any financial institution has going).
The idea, in part, is to become your own bank. You’re financing your large purchases yourself, using your life insurance policy, and paying interest to yourself instead of to a bank or finance company.
It’s not a new idea: I’ve seen the same concept in different forms, from Robert Castiglione’s LEAP to the Infinite Banking concept to Be Your Own Banker. Bank on Yourself seems to be the one that’s had the most success getting broad public buy in at the consumer level in recent years, though a lot of insurance agents use the LEAP system. And, in fact, before we had today’s large and easily accessible mutual funds, and term life insurance got so cheap, there was a lot of financial planning done using precisely this approach.
So should you use the Bank On Yourself approach? Well, as with so many things in financial planning, the answer is “it depends.”
The system is not a scam, by a long shot. And for certain people, it can work extremely well. It works so well, in fact, that banks themselves frequently use the cash value in life insurance policies as tier one capital on their own books, a concept called COLI, for company-owned life insurance.
But the concept is oversold. Actually, as with so many financial products and services and concepts, it’s undersold to the people who can benefit from it and oversoldto the people who can’t.
You will benefit most from the Bank on Yourself concept if you meet most of these criteria:
- You want or need a permanent death benefit.
- You have substantial free cash flow to devote to contributing a lot of premium into your policy
- That cash flow is from a reasonably stable source. There’s no reason to expect you’ll have to lapse it.
- You can pay the insurance policy up in full, with no more premiums due, by the time you retire.
- You have already contributed the maximum allowable to your IRA, Roth IRA or 401(k), or you don’t qualify.
- You make too much money for your children to be considered for need-based financial aid. Assets in life insurance cash values aren’t counted as parental assets for the purpose of computing need-based financial aid under the federal system.
- You’re going to need to start pulling money out within the next several years. Life insurance is a front-loaded product. Half your first year’s premium or more will go to paying commissions and fees. It takes years, typically, to reach the breakeven point on non-MEC whole life insurance policies.
- You own a small business and you can use the cash value as a reserve pool of money. (Historically, farmers frequently used loans from whole life policies to borrow money to plant in the spring, and paid their policy back at the harvest.)
- You like the tax benefits of the Roth IRA and you want to “go big” with more than $5,000 per year, or as much as you possibly can.
- You might want to retire prior to age 59½ and want a pool of money you can tap without paying penalties or committing to a Section 72(t) arrangement.
- Your state provides substantial asset protection to life insurance cash values.
- You want your assets to bypass probate at your death.
- You may have a substantial estate tax liability at your death, or the death of your spouse (whichever comes later), and your heirs will need substantial cash liquidity to pay the tax rather than liquidate assets in a hurry.
- You can do it and still get the death benefit you need to provide adequate protection for your loved ones (very important).
Important: Bank on Yourself and similar programs are not for you if you have trouble swallowing a term life premium to protect your family. Premiums on these whole life policies, when properly funded, will run thousands of dollars every year. You need to contribute to these policies at the same level you might fund a big 401(k).
It’s probably not for you if you consider yourself very risk tolerant, and you think you would prefer a bumpy 8 percent return to a smooth 6 percent.
So this isn’t a very revolutionary idea or anything. It’s really reverting to an older concept, and it’s pretty easy to do: You just need a highly rated whole life policy from a dividend-paying mutual life insurance company (stock companies won’t work) that does not practice direct recognition. (This means you still earn interest and dividends on all your cash values, even if you have borrowed against them. For example, you have $100,000 in cash value. You borrow $25,000 to buy a car at 6 percent interest. But the insurance company still pays you interest and dividends of, say 5 percent on the entire $100,000 you started with – not just on the $75,000 remaining.) Not every company does this. Two obvious examples of companies that do – that are excellent candidates for this kind of planning, include New York Life and Northwestern Mutual.
Downsides: While NYL and NM are both solid, proven dividend payors – as are most mutual life insurance companies, they can’t get blood out of a stone. They rely on treasuries to drive their returns, and yields on treasuries are extremely low. Current policyholders are benefiting from past higher yields. New policyholders should not expect to see the same level of dividend payouts as past generations of policy owners have seen.
I should quibble with some sleight of hand on Yeller’s part, too: She uses the fact that treasuries have outperformed stocks over the last 20 years, when that has nothing to do with expectations of future returns. You cannot expect treasuries to continue their past performance over 20 years if the same 20 year treasuries started 20 years ago with yields of 8 percent and now have yields of 3 percent.
Furthermore, Yellen uses the DALBAR study, which we refer to in a recent update, to note that the average investor only saw a return of 3.49 percent annually, for the last 20 years, once you took investor behavior into account. But this is sort of a cheesy metric: The 20 year returns on stocks are much better than what the typical investor will experience – and if you’ve made it this far into the article, and you use a financial planner (like me) you probably aren’t the “typical investor.”
The bottom line: This kind of planning has its place. But it also banks on Congress continuing to grant life insurance the same benefit of tax-free buildup of life cash value and tax-free withdrawals of dividends and tax-free loans. If the rules change, this is going to be tough to unravel.
Our approach, as with everything else, is to balance and diversify. I like this concept for the right people, with a portion of the portfolio – and frequently the portion you devote to safety. Whole life cash value is very stable.
But I don’t advocate using this concept for everything you do. Hold an IRA. Get some money in equities, annuities, and your own small business. Diversify, diversify, diversify.