Today we’re going to talk about the difference between infinite banking versus premium finance. You could really argue that one is just like a photo negative of the other. In fact, we’re going to have a visual later that shows the two.
But really, let’s explore what each one is. You can see the difference. What’s important? How do you do it?
Well, you use your own money to fund a policy out of pocket. So, you’re going to pay premiums out of your own pocket to build up policy equity. Then if you want to do things with your money, you’re going to borrow against the policy for those other things, like buying vehicles, investing in real estate, funding your business.
And in the long run, you really want to pay down these loans to some extent at least to increase your policy equity, whether it’s for more borrowing, like you want to keep fattening up the golden goose that’s going to keep laying the golden eggs, or you want to have a nice big fat bucket of tax exempt retirement income that you don’t have to pay back, that you can take via withdraw or loans that are paid off by the death benefit.
What’s the flip side? What’s premium finance? Well, premium finance is just the opposite. You’re going to borrow from a bank to pay those premiums. And then once you do, you can have your own money free to use for other things. You can’t keep borrowing against the premium finance policy because the bank already has a lien on it and usually there’s maximum leverage associated with it.
If you want to do those other things, you used premium finance to get your life insurance strategy over. You’re working on the side and then use your own money for these other things and in the long run, use the growth of the policy equity. Hopefully, it’s outrunning that bank loan and you use that to pay off the bank again via withdrawal or borrowing against the policy itself to pay off the bank and take control of the policy so you can use it for tax exempt retirement income or a lot of times estate planning.
Let’s go ahead and look at the lines or a visual of how these work. Many of you recognize these lines from our flagship video “banking basics”, where we compare just in a visual way, using life insurance as your own bank and borrowing against it versus paying cash for everything. We also have a mathematical example showing how borrowing against life insurance, often paying cash for everything and how badly it beats paying cash for everything.
In this video, though, we’re going to compare it to premium finance. But just a refresher. You’re paying your own premiums. You’re building up your policy equity and letting it compound into the future, immune from taxes, immune from market losses. And it continues compounding whether you borrow against it or not. It is like the money never left the policy. Why? Because the money never left the policy. The insurance company is letting you borrow against the asset and they’re just growing your cash value as if it never left. Why? Because it never left.
And this is true whether you use a policy loan or an outside loan with better lending features like a better rate or more convenience with a checkbook or an ACA. Premium finance, on the other hand, is just the opposite.
So you’re taking a loan incrementally over usually the first four to seven years. In this case, we have the first five years. You’re increasing your leverage and you’re using that to fund a policy. Now, the reason why it’s going down is because usually in the first years of the policy, those are the worst years and it doesn’t grow by as much as you put in. It usually catches up sometime after that sometime year five.
But we’re being conservative in saying it takes a little extra time because its performance is not that great. Maybe it does take a little extra time. And so therefore your policy equity is really in the green and there’s a shortfall. And when there’s a shortfall with premium finance, they expect you to keep collateral on hand. That’s that blue line. Usually, we use you we use blue to show if you were to pay cash for everything.
Well, you have to have some outside cash or stocks or municipal bonds or something to post as collateral for that shortfall between the policy equity and how much you’re borrowing. And if you don’t, you’re going to be upside down, and the bank is going to call the entire loan.
It is worth noting that if you want to use stocks, usually you have to double the stocks. They only give you about 50 percent loan to value muni bonds, 60 to 70 somewhere in there, usually about sixty five in cash. They’ll usually give you 100 cents on the dollar. Ninety something cents on the dollar. But as you can see, it takes a little while for the equity to kind of outrun and get to a positive state.
And at that point, that’s really what you’re looking for. The benefit to this is you’re out of pocket a lot less money. You’re posting collateral that if it’s in stocks or bonds, it’s at least working for you elsewhere.
And just by posting that collateral, you can borrow these big premiums of very pay. Interest payments to keep this policy afloat. Now it is also worth noting that this flat line entails that you’re paying interest along the way. We usually recommend that sometimes people will roll up interest, in which case this red line would go down. And you’re just hoping that the growth is outrunning the interest.
We recommend paying the interest every year because that way, at least you’re paying simple interest. If you’re paying it off every year at simple interest, you’re paying simple interest on a flat balance and you’re earning compound interest on an increasing balance. And you could, of course, pay down this loan if you wanted, which would raise this debt curve and also raise the equity curve. More often, though, what we see is people just pay the interest. And then after a certain amount of time, once the policy can handle its own loan, there’s enough equity to pay off the bank. The policy will pay off the bank.
Now, if you’re getting more favorable rates terms from the bank, maybe you keep the bank loan. But usually at some point there is an illustrated exit strategy of either withdrawing from the policy or borrowing against the policy to pay off the bank. And then after that, the policy equity grows from there.
So this is not exactly a scale model, but I wanted you to get the point compared to one of our other drawings. This is premium finance, again, using other people’s money for the policy so you can use your money for other things. That is not happening on the screen versus what the policy is, your own money to fund the policy so that later on you can borrow against it. And every time you make this loan, arguably you’re buying real estate vehicles, funding your business, whatever that looks like versus with the premium finance.
You’re doing all of that out of pocket with funds not being represented on this page. So hopefully that makes sense.
Let’s circle back and talk about why banking versus why premium finance. All right. So why premium financing? Before we jump into it, I do have to say that premium finance is traditionally reserved for not only high net worth, but ultra-high net worth. Individuals used to be around 10 million dollars of net worth. They lowered it to about five million of net worth.
Sometimes you can get around that by having very high income, around a half million dollars of income. And there are certain pooled programs that pool a lot of lower net worth individuals to qualify. But for the most part, it’s going to be for high net worth individuals. So they do it because they want maximum leverage at all times. They’re just all in on all kinds of their business, real estate, every penny spoken for. And they just want to be all in using OPM, other people’s money at all times. Their assets are all performing elsewhere.
So they just don’t have a lot of cash sitting around to just put in something like life insurance that’s going to grow safely and control their. They have very big projects and they have a very high hurdle rate, like they’re making a very high return on all of their money elsewhere. And the the reason why they’re doing premium finance is for passive either retirement or often real estate leverage. It’s because they’re posting this collateral. And usually it is performing assets like stocks or muni bonds.
Very rarely is it cash or sometimes maybe they get a letter of credit from their bank that says, hey, they have all this equity in real estate that we’re willing to lend against if they need it so they can just post assets that are already working for them, pay a very nominal amount in interest, especially these days, sometimes in the two threes, two to three percent, maybe even in the high one sometimes. And it’s so that they can get that extra leverage, whether it’s for tax exempt retirement or like I said, there’s a lot of benefits to estate planning.
In fact, if you visit our article on premium finance you can see there’s a lot of benefits to it. It also talks about the risk as well. So why infinite banking? Well, these are people that want to turbo charge a surplus of liquid assets. Infinite banking is great for people that have a lot of cash, have a lot of non-performing assets, have muni bonds that they want to diversify away from. And they want another place where they can get a safe, steady, controlled return, but stay safe and liquid so that they can use it for other things if they want to.
It’s really all about just having that control growth in between their opportunities. Maybe they just want to pause and let the real estate market cool off the stock market cool off. Maybe they just want to step aside and not lose to inflation.
And it’s for people that want maximum control, maximum access and maximum versatility. With these assets, obviously, you have an asset with premium finance, but it’s leveraged with the bank. So it’s think of having a mortgage, it’s like having a 95 percent mortgage and putting five percent down and paying a minimal amount of interest. It’s about something like that with premium finance versus infinite banking is, hey, you have all this equity and sometimes you may leverage it to the tune of 95 percent, but then you’re paying it down again to fatten up that golden goose so it can lay future golden eggs. That’s usually why people prefer infinite banking.
Hopefully this is really, really helpful to explain the difference between infinite banking and premium finance. Again, if you want to learn more about premium finance, visit our article on The Ultimate Guide to Premium Finance.
And if you want to learn more about Infinite Banking or Banking Basics. And you can always schedule an appointment with us and we can model this out for you and figure out what the best path for you is.
I hope you found this information helpful,
John “Hutch” Hutchinson, ChFC®, CLU®, AEP®, EA
Founder of BankingTruths.com