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We’re going to dissect the most confusing concept when it comes to infinite banking: direct vs non-direct recognition life insurance companies.
This concept deals specifically with how whole life companies credit dividends on loaned money when borrowing against direct vs non-direct recognition life insurance policies.
We’re also going to discuss 2 effective alternatives to direct vs non-direct recognition loans which can substantially enhance long term performance when practicing infinite banking:
- synthetic non-direct recognition loans
- signature loans
In fact, when it comes to infinite banking, both direct and non-direct recognition loans pale in comparison to these two far more efficient alternatives.
If you make it to the bottom of this article, you’ll learn about “Hutch’s Decision-Tree Logic” for choosing the right type of loan to optimize my own infinite banking strategy. There you will find my own personal deciding factors I run through when deciding which type of loan is best to take under different circumstances.
Let’s get into direct vs non-direct recognition and even better alternatives…
The easy way to remember the difference between direct vs non-direct recognition loans
Simply replace the word ‘direct’ with ‘effect.'” -HutchWith any whole life policy loan, there will either be an “effect” on your dividends when taking a direct recognition loan, or there will be “no-effect” on your dividends when taking a non-direct recognition loan. Here’s a simple example between direct vs. non-direct recognition life insurance: If you have $100,000 in whole life cash value and take a $25,000 policy loan:
- With a direct recognition company, the $25,000 of cash value collateralizing the policy loan would receive either a higher or lower dividend than the $75,000 you didn’t borrow against.
- With a non-direct recognition loan, your entire $100,000 of cash value would receive the exact same exact pro-rata dividends whether you take a loan or not against any portion of your cash value.
Non-Direct Recognition Life Insurance Companies: A Deeper Dive
In a vacuum, non-direct recognition sounds great! You borrow against as much of your cash value as you want, and the whole life company pays you the same dividend regardless of whether you have a policy loan or not
Think about it though. You know there’s no free lunch in life, especially when it comes to dealing with insurance companies.
If your money is not in the whole life company’s general account earning a return, how can they afford to pay you the same dividend as everyone else?
Here are 2 reasons:
- You’re subsidizing your own dividend through the non-direct recognition loan interest rate (which can and eventually will move up and down in tandem with your dividend returns)
- All other policyholders are essentially subsidizing your non-direct recognition dividend on your borrowed cash value in periods where there’s a disconnect.
Notice on the graphic below how insurance companies book a policy loan on their balance sheet as an asset.
Policy loans are indeed an asset to the insurance company. It’s essentially a risk-free bond on you. They lent you money and you pay them an interest rate. It just so happens they are holding your cash value as collateral and are able to keep paying your whole life policy guaranteed interest and non-guaranteed dividends mainly from the return you are paying them on that loan. So even though you are technically not “paying yourself back interest” when borrowing against a whole life policy used for infinite banking, the net effect can feel like you are.
Also, dividends are declared and set for the entire policy year. So whenever there’s a disparity between total return and whatever they’re charging you for loan interest, a non-direct recognition life insurance company must subsidize this disconnect from the other non-borrowing policyholders.
This is especially true for the smaller non-direct recognition companies. You see if the non-direct recognition life insurance company is HUGE, then they can distribute this slight disparity among tens or hundreds of billions of dollars’ worth of cash value. The smaller the non-direct recognition company, the more impactful this kind of disparity will be. And we consistently noticed that the smaller non-direct recognition companies (especially the ones that tout this feature tend to have watered down dividends compared to the juggernaut companies they’re competing with.
Again, there’s no free lunch. Either you are subsidizing your own loan, or the means must make up for the extremes in terms of collective policyholders entitled to dividends.
This non-direct recognition phenomenon by its very nature suggests that if the same company had implemented direct recognition loans instead, perhaps their dividend could be slightly higher for any non-loaned cash value.
…And that’s exactly what we’re seeing from the best dividend-paying whole life company for infinite banking which happens to be a direct recognition company.
That said, it’s a standard practice of the Banking Truths Team to show clients the 2 best direct vs non-direct-recognition companies and the impact of policy loans so they can compare for themselves. (At the bottom of this article you will find a button so you can book your own private analysis).
Direct Recognition Life Insurance: Overlooked & Misunderstood with Infinite Banking
Since direct recognition companies will “affect” the dividend they pay you on loaned money, you’re probably assuming that the dividends paid on loaned cash value will always be lower than the dividends paid on the portion of your cash value without a loan, and that’s simply not the case.
In terms of infinite banking, the direct recognition practice of paying a different dividend rate on loaned money is the reason why there’s a commonly accepted fallacy that taking a policy loan against dividend-paying whole life insurance will enhance your cash value growth.
You see, Nelson Nash was a Guardian agent in the year 2000 when he wrote The Infinite Banking Concept – Becoming Your Own Banker and ran the book’s whole life examples using Guardian’s whole life cash value calculator. Nelson demonstrated to readers how the policy actually grew more than if they had never taken a policy loan.
This was only true because Guardian is a direct recognition company, AND when the loan rate is above the dividend rate, a direct recognition life insurance company will pay an enhanced dividend to any cash value with a direct recognition loan against it.
Although I credit the late Nelson Nash for bringing the infinite banking concept to my attention as well as countless others, the masses are often misled and feel strongly that there is some infinite banking magic to using a policy loan.
You will learn below that nothing can be further from the truth once you understand alternatives like synthetic non-direct recognition or signature loans.
Being that we are in a low-interest-rate environment, you would probably think that direct recognition life insurance companies would be inferior since a lower loan rate than the dividend rate will drag down direct recognition dividends paid on loaned money.
Let’s go back to our “no free lunch” discussion…
A direct recognition company can segregate a special dividend pool for those borrowing against their policies. Since they can treat this smaller segregated pool of borrowed money separately than the much larger pool of cash value not leaving their general account, Direct recognition companies can potentially offer non-borrowers a stronger dividend than a non-direct recognition company can offer all policyholders.
That’s exactly what the best dividend-paying whole life company for infinite banking is doing, paying the strongest dividend in the business on non-loaned money.
And when you take a whole life policy with superior underlying performance (even if you encumber it with direct recognition loans most of the time) we often find that it still beats the best non-direct recognition companies by a wide margin. I’m even assuming that you’d be borrowing a significant portion of your cash value most of the time, which may be the case for certain nosebleed real estate investors or serial entrepreneurs.
What about your above-average Joe who’s using trying to be smarter with their safe and liquid capital? So, does it make sense for someone to sacrifice superior policy performance simply to be with a non-direct recognition company?
Some infinite banking proponents insist on it, but we don’t believe so.
Regardless, we like to take the opinion out of it for our clients by running an analysis between the best direct vs non-direct recognition life insurance companies, so they can see for themselves.
(Note: You can request to see that analysis of your own situation here.)
Once you learn about synthetic non-direct recognition and signature loans below, you probably won’t care whether your infinite banking policy is direct vs non-direct recognition because either one will be better using these alternative borrowing strategies rather than any policy loan type.
Synthetic Non-Direct Recognition Loans: An Efficient Infinite Banking Workaround
I can hear the alarm bells ringing in your mind now, “Wait, isn’t infinite banking about getting away from banks? What about credit checks? What about loans for retirement income I never want to pay back, etc.?”
First of all, you’re never fully getting away from banks when using a policy loan. This is yet another common fallacy I hear from fans of Nelson Nash’s book The Infinite Banking Concept – Becoming Your Own Banker.
Let’s face it, no whole life insurance company whether they’re direct or non-direct recognition is going to send your loan proceeds to you in small unmarked bills, golden eagles, or bitcoin.
The insurance company will either:
- wire the policy loan funds to an actual bank
- or they will send you a check that you eventually must deposit into an actual bank
You may want a better savings rate than they offer, but you can’t beat a bank’s best utility – convenience. For accepting their paltry return on your deposits, you get a branch with tellers, an ATM card, bill pay, a phone app, etc. Once you become your own banker with whole life insurance, you still want to utilize these exact same conveniences. Only you do so for a much smaller deposit amount. That way you can actually earn a return on the lion’s share of your savings.
Bob Hope famously said, “A bank is a place that will loan you money, once you can prove you don’t need it,” and that’s exactly how you create a synthetic non-direct recognition loan. With access to your policy loan in your back pocket, you hunt for the lowest rate you can find on the outside.
An ex-military business owner client once summarized it perfectly for me in a grizzled voice, “You mean once I become my own banker, I can go back to my loan officer and say ‘you better sharpen your pencil, buddy!’”
That’s exactly right, but the haggling has already been done for you with these synthetic non-direct recognition loans.
Banks already understand the safety and solvency of life insurance companies as you’ve seen in our flagship video on how big banks park billions of their tier 1 capital into bank-owned life insurance. Banks know that dividend-paying whole life insurance from the top mutual companies is A-paper, and really a no-risk form of collateral for them.
Therefore, a handful has created an entire loan category dedicated to people wanting a lower non-direct recognition type loan for infinite banking. Here’s what’s already teed up and ready to go for you with these synthetic non-direct recognition loans:
- You retain full ownership and control of your whole life policies
- You can aggregate all your family’s policies into one single line of credit
- Borrowing capacity up to 95% of total cash value from all family policies
- A convenience checkbook to initiate loans (write to yourself or any vendor. It’s a bank check)
- Loan rates between 3.24% – 3.75% depending on account size (as of April 2020)
You may ask, “Why would these banks go this low when insurance companies are charging between 5%-6% for policy loans?”
Think about it, this is such a low-risk loan. It’s like free money for them so they are incentivized to be more competitive than a policy loan.
What’s the catch? There must be a downside, right?
Ok, here are the only 3 disadvantages of using a synthetic non-direct recognition loan rather than a true policy loan:
- A policy loan is totally private, and a synthetic non-direct recognition loan requires an initial credit check. Your total available line and current balance will also show up on future credit reports.
- With synthetic non-direct recognition, you are required to make interest-only payments every month, whereas a policy loan is totally flexible. Using a policy loan, as long as your growing cash value exceeds the loan balance by a certain threshold there are no maintenance payments due.
- These banks often only accept the biggest, strongest, and oldest these dividend paying whole life insurance companies
So let’s drill a little deeper into these alleged downsides.
First of all, I don’t know why you wouldn’t choose one of the most solid and established mutual whole life companies over one of the fringe carriers anyway. I know many infinite banking agents are selling them, but when you peel back the sheets, you’ll find that this decision is often commission-driven. It should be no surprise that the best performing whole life companies are also the stingiest when it comes to commissions.
If a life insurance company is going to pay agents more, someone’s got to foot that bill.
Next, if you have credit problems you probably won’t qualify for this privileged loan type with sweetheart rates, so it’s a moot point anyway.
And if you do have good credit, then having an additional line open shouldn’t be a big deal, especially since at any moment you can always prove you have a corresponding asset backing the loan. I have business owner and real estate investor clients who ask for a cash value update every year to update their financial statements. They all have really big numbers in both the “assets” columns as well as the “liabilities” columns. That’s how they got to be successful in the first place.
Regarding the mandatory interest-only payments, you should want to pay the interest every month. Nelson Nash used to refer to this concept as “being an honest banker” in his famous book The Infinite Banking Concept – Becoming Your Own Banker. It’s how you flatten the loan curve and make sure your loan remains as simple interest versus a compounding loan balance against you.
Earning compound interest on a growing cash value account while paying simple interest on a flat or decreasing loan balance is a recipe for financial success!” -Hutch
What happens if…
- the bank alters their rates/terms?
- or I can’t make monthly interest payments?
- or I simply no longer want to be in debt to an actual bank any longer?
Not a problem. You simply call the insurance company and have them wire your full loan amount to the bank to absorb your current debt to them. You essentially just refinance from the synthetic non-direct recognition loan back into a whole life policy loan where you again have total privacy and complete flexibility over your payment structure.
However, the only 3 reasons you would probably do this would be:
- The insurance company starts offering a better rate than the bank
- You can’t make the interest-only payments (even though you could just borrow a bit more to do so)
- You need to temporarily erase any public debt to spritz up your credit report
You are never locked into this synthetic non-direct recognition loan arrangement… EVER. Remember, you are only getting this sweetheart loan because it’s backed by a corresponding asset that’s guaranteed to grow every year. If for some reason, you want out, just use the contractual loan provision inside your policy to absorb your synthetic non-direct recognition loan, and you’re done!
The main point I hope you learned about these synthetic non-direct recognition loans for infinite banking is this:
Rather than using whole life insurance to completely get rid of banks, you’re better off using banks to enhance infinite banking with your whole life policy.
For instance, the top 2 non-direct recognition life insurance companies are Mass Mutual and New York Life. Both non-direct recognition companies have a policy loan interest rate of 5%. Yet by creating your own synthetic non-direct recognition loan, you can wipe out 1.25%-1.76% of extra loan interest drag. So why wouldn’t you?
After becoming your own banker, shop around so you can be the best banker you can be.” -Hutch
Signature Loans: Another Non-Direct Recognition Alternative
Guess what, there’s something even better than these new synthetic non-direct recognition loan programs you just learned about. They’re called “signature loans.”
A signature loan is any loan you can get from an outside source that does not in any way reduce the borrowing capacity of your whole life policy. The 2 most common examples would be:
- An auto loan
- Any type of mortgage or real estate loan
One thing these 2 loans have in common is that they are backed simply by your signature as well as whatever the loan buys. For instance, when you finance a car, the loan is backed by your signature and the car itself.
If your signature turns out to be no good, they try and come after the car, not your whole life policy.
Here’s why signature loans are golden: you obviously still have the full capacity to borrow against your entire whole life cash value account (whether it’s direct or non-direct recognition or synthetic).
So, there are two clear reasons you would use a signature loan:
- The auto-dealership found you a lower rate than you could get from the insurance company or your synthetic non-direct recognition loan
- Even if the signature loan rate is higher, perhaps you need to keep the full borrowing capacity intact with your policy for an upcoming purchase or investment opportunity.
For instance, in 2018 I bought our brand new “Adventure Van” for around $50,000. Rather than pay cash, borrow against any of my policies using a direct vs non-direct recognition loan, use my synthetic non-direct recognition checkbook loan, I decided to initiate a signature loan right at the auto-dealership.
Below you can learn my full decision-tree logic on how I decide what kind of loan to take under any circumstance, but here was my thought process with taking a signature loan with the van:
Once I decided to purchase our brand new 2018 “Adventure Van” for $50,000:
- I could withdraw cash from several different family policies I have from Penn Mutual, Mass Mutual, and Guardian.
- But why would I, when I can earn interest and dividends while I borrow against any of them using their respective direct or non-direct recognition loans?
- However, none of them had a policy loan rate more favorable than my synthetic non-direct recognition checkbook loan at the time of 3.75% (now 3.25%).
- Before I stroked that synthetic non-direct recognition check, the auto-dealership found me an auto loan rate of 2.78% backed only by the van itself and my signature. WINNER!
You see even though I had my synthetic non-direct checkbook in my back pocket, I came to the finance department just like my grizzled ex-military client would:
“You want me to borrow money to buy your van? You better sharpen your pencil!”
So, not only did I get a much better rate, but I also still have over $40,000 of additional borrowing capacity inside my undisturbed whole life policies. I’m earning way more than 2.78% in all my policies, and I still have all my cash value available for other opportunities if they arise.
If for some reason my checking account ever gets temporarily low because I’m making these extra $800 payments at 2.78% interest, I write myself a $5,000 or $10,000 check from my synthetic non-direct recognition line to bridge the gap for a few weeks.
The same goes for mortgages and real estate loans. I know everyone wants the psychological bliss and bragging rights of having a paid-off mortgage, but with today’s low rates, it’s better to borrow as much as possible, while keeping control of your cash growing inside a dividend-paying whole life policy.
Here are 5 reasons to send mortgage over-payments to whole life insurance instead:
- A properly structured whole life policy will often earn a higher rate than the mortgage interest rate (which may be deductible to boot)
- If you die too soon, the death benefit provides enough tax-free cash to keep your family in the home for perpetuity
- If you become disabled and must abandon the home, you won’t get a refund for any extra principal you’ve paid on a mortgage, but you’d still have all your whole life cash value if you made those extra payments there instead.
- If your whole life policy has a chronic illness rider, you may be entitled to a substantial advance of your death benefit (over and above your cash value) which could keep you in your home and/or pay for needed care.
Remember, your real estate appreciates in value regardless of whether it’s fully paid off or fully leveraged. Paying down a loan early only erases some of the interest due. So, if you can steadily earn a greater growth rate in whole life while keeping full control of your liquid capital, why would you relinquish that control… especially when it props up additional protective benefits?
Hutch’s Full Decision-Tree Logic When Choosing the Correct Loan to Optimize His Infinite Banking Strategy
How do you know which type of loan to take and when?
Whenever I need access to capital for any substantial purchase or investment, I consider all the following factors:
- Where can I get the absolute lowest rate, and can I service the monthly interest?
- How much convenience do I want in taking the loan?
- Do I need absolute privacy or to consider credit score cosmetics with this loan?
- Will I need my maximum capacity to borrow in the near future?
- Do I need my credit score to look fabulous?
Let me walk you through my thought process for each…
Where can I get the lowest rate and payment? Signature Loans or Synthetic Non-Direct Recognition
Anyone who tells you there is some magic to borrowing against a whole life policy rather than a lower rate outside line is either misinformed themselves or a charlatan. Either way, it’s absolute nonsense and they should not be trusted.
However, when using a synthetic non-direct recognition loan, you will have to at least service an ongoing interest-only payment to do so.
If you use a signature loan you will probably have to pay principal as well, so even if the rate is slightly lower, you will have a higher payment.
Remember too, that if you can’t pay the interest or borrow a bit more from the onset to pay the interest each month, then you must use a totally flexible policy loan.
Let’s move on…
How convenient is the loan? Synthetic Non-Direct Recognition
Sometimes you just need the capital, and you may not want to fill out paperwork, go through secure verification of your identity, or sit on the phone with an insurance company to go through the process of borrowing from each policy (not to mention paying back the loan on each).
Stroking a single check from my synthetic non-direct recognition line against all my family’s policies is the clear winner for convenience.
Do I need absolute privacy or credit score cosmetics? Direct or Non-Direct Life Insurance Policy Loan
Most of the time this won’t matter, but you may be trying to qualify for credit in the near future (soon to be buying a house or investment property). If so, a big loan that pushes the limits using your synthetic non-direct recognition line may bring down your credit score and cause you to get adverse rates/terms on a long-term real estate loan.
You may want to refinance the synthetic non-direct recognition loan back to your whole policy loan (even if only temporarily). Even though a direct or non-direct recognition life insurance loan won’t be as mathematically efficient, the complete privacy of this arrangement may be worth it.
Keep in mind though that this only matters if the real estate transaction is imminent. If investing in real estate is more of a long-term goal, remember that you have enough runway to have your policies absorb any balance you have with the synthetic non-direct recognition companies.
Once you consummate the real estate transaction, you reestablish your synthetic non-direct recognition line for better long-term efficiency.
Will I need my maximum capacity to borrow in the near future? Signature Loans
You may need that maximum capacity when you’re planning to do something big like buying a house, a business, an expensive vehicle, or piece of equipment, and you know you’ll need every dollar you can get your hands on.
If so, then leading up to this purchase date, you’ll want to buy everything prior to using signature loans, even if they’re at a higher rate. Then you can utilize the full capacity of your whole life policy’s direct or non-direct recognition loan (if privacy is needed) or your synthetic non-direct recognition line.
Because borrowing against your cash value in any way will reduce your future capacity even if these sources have better rates and terms than temporarily using less efficient signature loans until you can absorb them or pay them off.
Let’s face it, having the cash to acquire certain assets in a timely manner far outweighs paying a point or two more for other things along the way when acquiring such an asset.
Conclusion on Direct vs Non-Direct Recognition Life Insurance Loans vs Alternative Loans
As you can see the direct vs non-direct recognition debate isn’t as clear and simple as many pundits would have you believe. Plus, if you focus your entire infinite banking strategy using only direct or non-direct recognition policy loans, you’d be missing out on their performance-enhancing cousins. The notion that there is some infinite banking magic to a policy loan is a complete myth.
Since you now know how to acquire much more efficient loans than your stock direct or non-direct recognition life insurance loans, you should only utilize a policy loan for 2 reasons:
- Absolute privacy
- Absolute flexibility
Otherwise, you should definitely enjoy a substantially lower rate, greater convenience, and/or more total loan capacity using one of these viable infinite banking alternatives:
- Synthetic non-direct recognition loans
- Signature loans
At the end of the day, the main driver of how successful your infinite banking strategy is comes down to superior performance from the underlying dividend-paying whole life insurance policy.
Infinite banking agents often like to hype the frosting rather than the cake, often for their own selfish reasons.
Our philosophy is to show our clients the very whole life performers from both the direct and non-direct recognition life insurance companies, educate them about the pros and cons of each, and let them decide for themselves which makes the most sense for their own banking strategy.
You can tap the green button under the pic below to have us walk you through that analysis whenever you’re ready.
John “Hutch” Hutchinson ChFC®, CLU®, EA, AEP®, CExPs®
Founder of BankingTruths.com