Q&A: Infinite banking, life insurance, cash value, policy loans

As a financial professional who has spent years helping clients optimize their finances through properly designed whole life insurance policies, I’m often asked detailed questions about how these policies work and how they can be leveraged as part of the Infinite Banking Concept. Today, I’d like to address 9 common questions that came up in a recent discussion. These questions and answers should be helpful for anyone using or considering cash value life insurance as part of their financial strategy.

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1. Do I get to choose the interest rate on a policy loan?

This is a great question to start with, as the answer is both yes and no. When you take a standard policy loan, the insurance company sets the interest rate. However, if you’re practicing the Infinite Banking Concept, there are effectively two loans at play:

The loan between you and the insurance company, where the rate is set by the insurer.
The loan between you and wherever you deploy that money (yourself, your business, an investment, etc.).

For the second loan, you have control over the interest rate. For example, if you use a policy loan at 5% to pay off a 12% credit card, you could choose to continue “paying yourself back” at 12%. This allows you to recover more of the interest you would have paid elsewhere while still satisfying the insurance company’s loan terms.

2. If the dividend is 5% that I’m earning in a policy and my interest rate for a policy loan is 4%, am I making 1% on that deal?

This is a common misconception. While it might seem logical to simply subtract the loan interest rate from the dividend rate, it’s not that straightforward. The dividend rate (in this case 5%) refers to the earnings the insurance company is making on their investment portfolio. Expenses and mortality costs are subtracted from this before it impacts your cash value growth.

Additionally, these percentages are applied to different numbers – the dividend to your total cash value, and the loan interest to just the amount borrowed. Therefore, you can’t simply subtract one percentage from the other to determine your net gain.

3. How is the dividend rate determined?

The dividend rate is declared by the insurance company and is typically based on their investment portfolio performance. However, it’s not a direct translation to policyholder returns. The company considers several factors:

They set aside some earnings in a contingency fund for future years.
They account for company expenses and mortality costs.
They determine how much can be shared with policyholders.
They distribute this amount among policyholders based on factors like policy size and duration.

It’s important to note that you can’t compare companies solely based on their stated dividend rates, as the actual impact on policy performance can vary significantly.

4. Is the dividend rate the same as the compounding annual growth rate of the cash value?

No, these are different metrics. The compound annual growth rate (CAGR) is something we can calculate retrospectively based on actual policy performance. It takes into account guaranteed growth, paid dividends, and how those dividends were used within the policy. The dividend rate is just one component that contributes to the overall CAGR of a policy’s cash value.

5. What is the interest rate the guaranteed cash values compound at?

This is a bit of a tricky question because guaranteed cash values aren’t typically expressed as an interest rate. Instead, they’re specific dollar amounts guaranteed by the insurance company based on premiums paid. These values account for a conservative estimate of the company’s investment returns, expenses, and mortality costs.

In the past, many contracts were based on a 4% portfolio return for the insurance company. However, this doesn’t mean the policyholder sees a 4% return, as expenses and mortality costs are subtracted before determining guaranteed values.

When evaluating a whole life policy, it’s crucial to focus on the actual guaranteed cash values rather than trying to reverse-engineer an interest rate. These guaranteed values are what you can count on, regardless of the company’s actual performance.

6. When I repay a policy loan with interest, am I paying myself back?

In a sense, yes, but it’s not as direct as some people think. When you repay a policy loan, the interest goes to the insurance company. However, if you’re with a mutual insurance company (which I generally recommend), you’re a partial owner of that company. The interest payments contribute to the company’s profits, which can then be distributed back to policyholders in the form of dividends.

Additionally, if you’re practicing the Infinite Banking Concept and chose to “charge yourself” a higher interest rate than the insurance company requires (as discussed in question 1), that extra interest does indeed go directly back to you.

7. Does the interest I owe on a policy loan change every month if I’m repaying it with principal and interest monthly?

The interest rate itself doesn’t change, but the amount of interest you owe does decrease as you pay down the principal. Insurance companies typically calculate interest annually, but they will adjust for principal payments made throughout the year.

For example, if you take a $20,000 loan at 5% interest, the company will initially reserve $1,000 for interest. If you pay back $10,000 halfway through the year, they’ll credit back $250 of that reserved interest, as you no longer owe interest on the repaid portion for the second half of the year.

8. When I borrow money from my whole life policy, how does that affect the guaranteed growth of my policy? How does it affect dividends and how does it affect the face value?

This is an excellent three-part question:

Guaranteed Growth: Taking a policy loan does not affect the guaranteed growth of your cash value. This is a crucial feature that makes the Infinite Banking Concept work – you can use your money elsewhere while still benefiting from the guaranteed growth inside the policy.
Dividends: The effect on dividends depends on whether the insurance company uses “direct recognition” or “non-direct recognition” for policy loans. Direct recognition companies may pay a different dividend rate on policies with outstanding loans, while non-direct recognition companies pay the same dividend regardless of loans. Neither approach is inherently better; it’s just a different way of accounting for policy loans.
Face Value (Death Benefit): A policy loan does not directly reduce your death benefit. However, if you pass away with an outstanding loan, the loan amount plus any unpaid interest will be deducted from the death benefit before it’s paid to your beneficiaries. It’s important to remember that this isn’t “losing” part of your death benefit – you’ve simply chosen to use some of it during your lifetime.

9. Can an insurance company alter my whole life insurance policy contract if I start flight lessons?

This question touches on the “contestability period” of life insurance policies, which is typically two years from the policy issue date. During this period, if you engage in activities you said you wouldn’t (like becoming a pilot) and then pass away as a result, the insurance company could potentially contest the claim and refund premiums (with interest) instead of paying the death benefit.

However, after the contestability period (assuming you were truthful on your application), the insurance company cannot alter your contract or deny a claim based on new activities you take up. The only exception would be if you had misrepresented your age on the application, in which case they could adjust the death benefit based on your true age.

Learn More and Thrive

Understanding these nuances of whole life insurance and policy loans is crucial for anyone looking to maximize the benefits of their policy, especially if you’re using it as part of an Infinite Banking strategy. Remember, a well-designed whole life insurance policy can be a powerful financial tool, offering guarantees, tax advantages, and flexibility that many other financial products lack.

At McFie Insurance, we specialize in designing high cash value whole life insurance policies tailored to each client’s unique needs and goals. If you’d like to learn more about how whole life insurance can fit into your financial strategy, or if you have questions about your existing policy, I invite you to schedule a strategy session with us. Together, we can work towards creating a financial future that gives you more control over your money and helps you build lasting wealth.

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