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When people first learn about the Infinite Banking Concept (IBC), one of the most appealing features is the ability to access policy cash values through loans. Many proponents make bold claims that sound almost too good to be true: “You recover all the interest you pay,” or “There’s no net cost to borrowing from your policy.” While these statements contain a kernel of truth, they can create confusion about the real cost of policy loans and how policy guarantees work.
Policy loans do have a cost. Understanding this cost, along with the guarantees built into your whole life insurance policy, will help you make better financial decisions and use your policy more effectively.
The confusion around policy loan costs stems from some well-intentioned but misleading explanations of how the Infinite Banking Concept works. The idea goes something like this: If the insurance company pays you a 6% dividend rate while charging you only 5% on your policy loan, you’re coming out ahead. Therefore, the loan is “free” or even profitable.
This sounds logical at first glance, but it’s not accurate.
When you take a policy loan against a whole life policy, the insurance company lends you money from its general fund using your policy values as collateral. Since cash value represents your equity in the death benefit, the insurance company faces no risk by making you a loan up to the amount of your cash value. If you don’t pay back the loan, they will just deduct the outstanding balance from your death benefit when you die.
There is always a cost of interest with any policy loan. The loan rate can be variable or fixed. Variable loan rates are usually adjusted once per year at the policy anniversary date and are often based on a bond index. Interest on policy loans is simple interest, though if you choose not to pay the interest, it will be added to the loan balance and compound annually at the policy anniversary date.
The growth in your policy isn’t automatically enhanced by taking a policy loan and repaying it.
Many advocates of the Infinite Banking strategy argue that you “recover all the interest” you pay the insurance company. This can be true in a limited sense, but it leads to confusion around the real cost of policy loan interest.
The key to understanding this comes from looking at R. Nelson Nash’s examples in his book “Becoming Your Own Banker.” When you read the context of his examples, you discover something important: the interest on policy loans was often paid by dividends in Nash’s examples. The “interest” paid by the client was actually additional premium, not loan interest at all.
Nash was able to add base premium payments beyond his original policy design without causing a Modified Endowment Contract. This is exactly what he did. The interest he paid to the insurance company went to increase the cash value of his policy, but it was structured as an additional premium equal to the amount of interest he would have been paying to a finance company.
Let’s look at how policy loans impact your policy values over time. When you have an outstanding policy loan, you are still earning guaranteed growth and dividends on your full cash value. However, you are also paying interest on the loan balance.
The cost of policy loan interest is only “recovered” over time and to the extent a policy loan is not outstanding. Here’s what this means in practical terms:
If you take a single loan for a specific purpose (like buying a car or funding a vacation) and pay it back over two years, then let your policy continue growing for decades without further loans, you can indeed “recover” all of the interest cost through the continued compounding growth of your policy values.
If you have large policy loans outstanding for extended periods, the efficiency diminishes. The more loans you have outstanding, and the longer they remain outstanding, the less efficient the process becomes. In some cases, maintaining large policy loans for your entire life can actually result in a net negative cost rather than a net positive benefit.
This is why it’s important to be strategic about when and how you use policy loans.
In today’s environment, with interest rates fluctuating and market conditions constantly changing, it doesn’t always make sense to use a policy loan. When interest rates are low in the broader market, it makes better sense to use money at a lower interest rate rather than paying interest to the insurance company at a higher rate.
This statement appears to conflict with some of Nash’s examples, but remember the context: Nash was developing the Infinite Banking process during the early 1980s when bankers were charging 21.5% or more for loans, while his policy loans were available at 5% to 8%. Later, in the late 90s when he wrote his book Becoming Your Own Banker, interest rates were still relatively high. The best decision was obvious in these environments.
From around 2000-2021, the situation was reversed. For much of the last two decades, interest rates on policy loans were higher than market loan rates. This means you might have been able to get a bank loan at 4% while your policy loan cost you 5% to 6%. In these circumstances, using the policy loan costs you money rather than saving you money.
The question then becomes, should you still use a policy loan at a higher rate than loans available on the open market?
The answer depends on several factors, including your financial strategy, tax considerations, and the circumstances of your situation. But the blanket statement that policy loans are always the best choice is not accurate.
Now let’s turn our attention to the guarantees in your whole life insurance policy, because understanding these guarantees is essential to making informed decisions about your policy.
Every permanent life insurance policy has an illustration that shows both guaranteed and non-guaranteed values. This distinction is crucial.
The guaranteed portion of your policy illustration shows you the minimum cash values and death benefit that the insurance company is contractually obligated to provide. These values are backed by the full faith and credit of the insurance company, and they can’t be reduced under any circumstances (assuming you pay your premiums as required and interest on any outstanding policy loans).
For a well-designed participating whole life policy, you can typically expect to see guaranteed internal rates of return on premiums to guaranteed cash value ranging from 0.5% to 2.5% long-term on the guaranteed cash values. This may not sound impressive compared to stock market returns, but remember: these returns are guaranteed, they are after all fees, and taxes are not required unless you withdraw the money directly. Using policy loans, the money can be accessed tax-free for the rest of your life.
The guarantees in a participating whole life policy are remarkable when you consider the long-term track record. State laws prohibit life insurance companies from filing bankruptcy in all 50 states. Throughout the history of life insurance in the United States, life insurance companies have maintained a solid track record. Since January 1, 2010, 369 banks have failed while only 20 life insurance companies have been placed into receivership.
This track record is why life insurance companies who issue participating whole life insurance policies are so dependable. Many of these mutual life insurance companies have been paying dividends to policyholders for well over 100 years.
The non-guaranteed portion of your policy illustration includes projected dividend payments. Dividends are paid to policyholders based on the profits the insurance company has earned over the past year. These dividends are determined by the insurance company’s board and are paid annually to policyholders on the policy anniversary date of each participating policy.
Dividends are not guaranteed. However, once a dividend is paid, it becomes guaranteed and cannot be removed from the policy without the policyholder’s specific authorization.
Some insurance companies are conservative when projecting future dividends illustrated in the non-guaranteed portion of the illustration. Other companies tend to be more optimistic with their dividend projections. It’s important not to purchase a policy based only on non-guaranteed values. If the guarantees are not something you would be happy with, you should rethink purchasing the policy.
For most well-designed policies, you can reasonably expect to see an internal rate of return of 2% to 4% on premiums to the non-guaranteed cash values (with dividends) over time. But again, these are projections, not guarantees.
One of the most impressive features of participating whole life insurance is how the guaranteed returns accelerate over time. Let me illustrate this with an example.
A 30-year-old male purchasing a participating whole life policy might see only a 1% guaranteed increase in cash value above the annual premium paid in year five. This doesn’t seem remarkable. As the policy matures, the guaranteed cash value increases compared to the annual premium paid become extraordinary:
In year 10, the guaranteed increase might be 39% above the annual premium. By year 20, it could reach 76% above the annual premium paid that year. And it keeps getting better year after year.
This happens because of the way the policy is engineered. As Nelson Nash wrote, “the policy is engineered to become more efficient every year, no matter what happens.”
At a certain point (often around age 75 in a well-designed policy), the policyowner can choose not to pay further premiums. Each year thereafter, they would still be guaranteed a cash value increase based on the policy’s compounding growth, which tends to insulate the cash values from inflation and can provide the policyholder with free cash flow for the rest of their life if arranged in a sustainable way.
Beyond these guaranteed numbers, participating whole life policyholders are able to earn dividends based on the performance of the insurance company’s investment portfolio. When dividends are directed back into the policy to purchase additional paid-up insurance, they increase the cash values by increasing the face value of the policy.
It is customary to see large annual cash value increases compared to the annual premium paid in the later years of a participating whole life insurance policy. These annual returns on premiums paid, make the speculative assumptions in some investment portfolios look anemic in comparison.
This is why so many wealthy individuals, business owners, corporations, and even banks themselves own and use life insurance for asset allocation. Your death benefit is what makes this kind of growth possible. The death benefit is how the insurance company spreads out and plans to cover the risk they face while providing these remarkable returns over the premiums paid each year.
Given what we now understand about policy loan costs and policy guarantees, how should you approach using policy loans as part of your financial strategy?
First, recognize that policy loans are a tool, not a magic solution. They can be extremely valuable in the right circumstances, but they’re not always the best choice.
Consider using policy loans when:
Tax advantages apply. When you take a policy loan for a business or investment purpose, the interest can be tax deductible as an investment interest expense. This lowers the effective rate on your policy loan even though you still pay the full interest to the insurance company.
Alternative financing is expensive or unavailable. If market interest rates are high, or if you don’t qualify for traditional financing, a policy loan may be your best option.
Speed and convenience matter. Policy loans are usually processed within days with no credit check, no application process, and no fees. This convenience can be valuable in time-sensitive situations.
You want to maintain liquidity elsewhere. Sometimes it makes sense to take a policy loan rather than liquidating other investments, especially if those investments are performing well or if selling them would trigger tax consequences.
Consider alternative financing when:
Market rates are significantly lower. If you can get a bank loan at 3% while your policy loan costs 5%, the bank loan may make better financial sense while keeping your life insurance cash values in reserve.
The loan will be outstanding for an extended period. Long-term policy loans reduce the efficiency of your policy’s growth. For major purchases or investments that will take many years to repay, carefully consider the total cost.
You’re not disciplined about repayment. One of the dangers of policy loans is that there’s no required repayment schedule. If you lack discipline in repaying the loan, it can erode your policy values over time as the interest adds to the loan balance.
Policy loans are not no-cost loans. They do have interest costs, and those costs can add up over time, especially if large loans remain outstanding for extended periods.
When used strategically and in the right circumstances, policy loans can be a valuable financial tool. They offer flexibility and tax advantages that are difficult to find elsewhere. Combined with the guarantees and long-term growth potential of a well-designed participating whole life insurance policy, they can play an important role in building sustainable wealth.
The key is to understand the costs and the guarantees, to be realistic about how policy loans work, and to make informed decisions based on your financial situation and goals.
Don’t buy into claims that policy loans are “free” or that you automatically “recover all the interest.” Instead, understand the real costs, evaluate them against your alternatives, and use policy loans strategically as part of your financial plan.
When you do this, you’ll be positioned to make the most of your participating whole life insurance policy while avoiding the disappointment that comes from unrealistic expectations. This is the path to true financial peace of mind and sustainable wealth building.
Q: If I take a policy loan, does my cash value stop growing?
A: No. Your full cash value continues to earn the guaranteed growth rate and receive dividends. The insurance company lends you money from their general fund using your cash value as collateral. However, you are simultaneously paying interest on the loan balance, which creates a net cost that offsets some of that growth.
Q: What happens if I die with an outstanding policy loan?
A: The insurance company deducts the loan balance plus any accrued interest from your death benefit before paying your beneficiaries. For example, if your death benefit is $500,000 and you have an outstanding loan of $75,000, your beneficiaries would receive $425,000.
Q: Do I have to make payments on a policy loan?
A: No, there’s no required repayment schedule. This flexibility is valuable, but it can also lead to discipline problems. If you never repay the loan, the interest will compound annually and could eventually consume your cash values, significantly reduce your death benefit or cause the policy to lapse and create a tax liability. The most successful policy owners make regular payments even though they’re not required to.
Q: Are policy loans really tax-free?
A: Yes, policy loans are generally tax-free as long as the policy remains in force. However, if you surrender or lapse your policy with an outstanding loan, you could face a taxable event. Also, if your policy becomes a Modified Endowment Contract (MEC), different tax rules apply. As long as you maintain your policy and follow the guidelines, policy loans provide tax-free access to your money.
Q: How long does it take to get a policy loan?
A: Most insurance companies process policy loan requests within 3 to 7 business days. There’s no application, no credit check, and no underwriting process. You simply contact your insurance company or agent and request the funds. This makes policy loans extremely valuable for time-sensitive opportunities or emergencies.
Q: Can I still use my policy for retirement income if I’ve taken loans during my working years?
A: Yes, but the amount available depends on how you managed those loans. If you consistently repaid them, your policy should be in good shape for retirement income. If you never repaid large loans, the outstanding balance will reduce what’s available. The key is strategic planning and disciplined loan management throughout your working years.
Tomas P. McFie DC PhD
Tom McFie is the founder of McFie Insurance and co-host of the WealthTalks podcast which helps people keep more of the money they make, so they can have financial peace of mind. He has reviewed 1000s of whole life insurance policies and has practiced the Infinite Banking Concept for nearly 20 years, making him one of the foremost experts on achieving financial peace of mind. His latest book, A Biblical Guide to Personal Finance, can be purchased here.
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