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Be Your Own Bank: Cash Flow Banking is Appealing, but It's Rarely Practical

You can borrow money interest-free from your insurance policy instead of a bank -- but the policy you'll need has a high price tag.

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Sarah Tew/CNET

Whether it's through student loanspersonal loansmortgagescredit cards or car loans, the amount of interest many of us pay for financing is significant. In 2021, the average consumer held $96,371 in debt, increasing more than $3,000 from 2020, according to credit bureau Experian. Paying interest in exchange for financing is a fact of life for most of us, but with interest rates rising as the Fed attempts to quell staggering inflation, borrowing money is becoming even less affordable.

Cash flow banking, also known as "infinite banking", is designed to circumvent this conventional path toward institutional debt, mitigating your dependency on banks and reducing the amount of interest you pay. The concept is simple: When you need money, you borrow from yourself -- or, rather, your own insurance policy. 

Sound good? While cash flow banking may have broad appeal, it's usually an impractical strategy for anyone except the wealthiest. It's a long-term play that requires significant expenditures early on in life in order to reap the benefits later on. Read on to learn more about what cash flow banking is, how it works -- and whether it's a scam.

What is cash flow banking?

In the 1980s, an insurance agent named Nelson Nash developed a financial strategy that reduced clients' reliance on high-interest loans from traditional banking institutions. In his book Becoming Your Own Banker, Nash encouraged readers to take out a life insurance policy and borrow from it when needed. His strategy became known as the cash flow banking method.

Again, the concept is simple. First, you secure a low-interest loan from a mutual insurance company. Then, when you need money, you draw on your accrued funds. Instead of paying a high interest rate to a lender, you take advantage of your policy's low interest rate and repay yourself -- and whoever ultimately inherits the proceeds of your life insurance policy

What type of life insurance policy do you need for cash flow banking?

There are plenty of kinds of life insurance, but two of the most well-known are whole life and term. Most people have term life insurance, which is cheaper and covers you over a certain period of time.

Whole life insurance is significantly more expensive. According to PolicyGenius, the average term life insurance premium costs between $21 and $152 per month. Whole life insurance covers you for the entirety of your life -- so you don't have to worry about outliving your policy. As a tradeoff, you pay higher premiums: The average whole life insurance premium costs between $481 and $571 per month. 

The cash flow banking strategy is built upon whole life insurance -- because you can borrow against that type of policy. 

How does cash flow banking really work?

The first step is to purchase a whole life insurance policy. Next, you'll have to wait a while -- like decades -- for your policy to increase in value. Ultimately, when you need a loan, you can borrow against your policy instead of a loan secured from a traditional lender. Although you are technically borrowing against your own policy, the money you borrow comes from a general fund within your life insurance company. Whenever you take out a policy loan, your whole life insurance policy serves as collateral. 

Keep in mind, it can take years to build up a significant enough cash value to borrow funds. If you're hoping to take out a large loan, it may take decades. As such, cash flow banking toward a down payment for a house won't work for everyone. You'll gain the most value from it decades down the road -- if you're able to keep up with the high monthly premiums.

How to choose a whole life insurance policy

A whole life insurance policy is the bedrock of cash flow banking -- and setting up your policy correctly is key. First, you'll want to shop for a policy that offers dividends, which are payouts from the insurance company's earnings to its policyholders. Dividends may be distributed annually -- but they're not guaranteed. Ideally, you can end up paying your premiums, or at least a portion of them, with the dividends you earn each year.

Another important factor is paid-up additional insurance. Paid-up additions are optional coverage "boosters" that can increase your life insurance policy's cash value -- and earn you greater dividends (and interest). Paid-up additional insurance is typically purchased with dividend earnings rather than a higher premium.

Are there tax incentives to the cash flow banking method?

There are a few. With a whole life insurance policy, the death benefit is paid out tax-free to the heirs of your estate. And dividends from a life insurance policy are also tax-free -- meaning that there are no taxes on any loans or withdrawals made from your policy or appreciations in its value. 

OK, but is cash flow banking a scam?

No. It's an esoteric, though valid, strategy that requires an amount of resources, investment and patience that's out of reach for most people. 

Benefits of cash flow banking

Here are a few reasons why cash flow could be beneficial:

  • Low interest rates: Insurance companies generally charge lower interest rates than traditional lenders and credit card providers. 
  • Dividends may not decrease after you borrow: Most banks and financial institutions use "direct recognition" when paying interest on your savings; that is, they pay interest only on the cash in your account. When you withdraw $10,000 from a $30,000 account, for example -- you'd earn interest only on the remaining $20,000. Some insurance companies will pay you the same dividend, however, even if you've borrowed against your policy. In that case, you'd keep earning dividends on the entire $30,000.
  • Quick access to cash: Since you'll be borrowing funds from your own insurance policy, you're quickly able to secure cash when you need it -- no need for an application to be approved and processed.
  • Tax benefits: Life insurance policy funds are tax-free.
  • Flexible loan terms: If you're unable to repay the loan, the balance and interest of the loan is subtracted from your policy -- a much better alternative to defaulting on a conventional loan.

Downsides of cash flow banking

Cash flow banking may be an effective strategy for some, but for most of us, it's not a practical way to manage our money or finance major purchases. Here are a few disadvantages of the method: 

  • Dividends aren't guaranteed: Although mutual insurance company dividends tend to be fairly reliable, they aren't guaranteed. If dividend payouts are a part of your cash flow banking strategy, it's a risk.
  • Premiums are expensive: Whole life insurance policy premiums cost significantly more than term life insurance. And if you miss a single payment, you risk forfeiting your policy. For this reason alone, cash flow banking can be risky for anyone who is not entirely confident they can comfortably afford premiums for the long haul. 
  • Life insurance policy funds take time to build. Before you borrow, you'll need to grow your policy. This could take decades. And if you need a loan before you accrue the value, it could subvert your whole strategy. 

Is cash flow banking right for me?

Cash flow banking may be a stretch for most of us. But if you can afford the high premiums, and understand the risks involved, it can provide flexible liquidity -- without interest. That noted, if you can't afford a whole life insurance policy, term life insurance is a worthwhile investment that can offer financial protection to you and your family. 

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