I was talking with a life insurance agent friend of mine the other day. He had called to ask me about my ongoing research and interest in the infinite banking or being your own banker concept. He thought there was another route I might want to look at.
This agent suggest that instead of using dividend paying whole life insurance, that a person had a chance of doing much better (accumulating more cash value) if they used an indexed universal life insurance policy. After all, he said, indexed UL’s were illustrating interest rates around 8%, higher than the 5%-6% dividends that the best of the whole life insurance companies were paying.
I suggested we pick at it a little. The first test for me is always the guaranteed basis test. Anyone can illustrate interest or dividends, but at some point there needs to be a reality check. Not too long ago I was looking at an indexed UL that had a guaranteed 1% interest rate and an assumed interest rate of 8.2%. Who in their right mind really believes that you can assume you will make 8.2% over the life of your policy. I’m hard pressed at this point in time to believe that the policy will ever pay 8.2% in any given year, let alone for the life of the policy.
So, let’s consider the basis of infinite banking. You buy a whole policy and use dividends to buy paid up insurance. You fund the policy as close to a MEC as possible which will allow you to have most of the premium going toward paid up additions. The base policy is an interest earning whole life policy with a term blend to keep the cost of insurance lower, so it builds cash value at a guaranteed rate of 3%-4% depending on the company. It’s the engine at the front of the train. Now, paid up additions are really kind of neat. They are the rest of the train.
Let’s say you are funding your policy with $5000 extra dollars every year above the base policy. I’ll use approximate figures from a policy that a client just put in force. That $5000 a year buys about $18,000 of paid up life insurance, so in the case of this policy it started with a face amount of $250,000 and at the end of the first year it has a face amount of $268,000 and because of the extra $5000 used to purchase the paid up $18,000, it has immediate cash value of very $4960. So, the small amount of cash value in the base policy is building interest and the additional $4960 is now building interest too. Different companies have different names for the additional cash that goes into the paid up additions, but for honesty sake let’s just call it over funding.
Before long, because of modest compounding interest, the over funding starts building cash value, guaranteed that is, well, impressive. Is it a get rich quick scheme? Not even close. If you’re not in to the policy and concept for at least 20 years, it won’t work to its’ optimum.
So back to my first test, guarantees. I ran an illustration for the client above using a dividend rate of 0% for the life of the policy and the guaranteed 4% interest rate and the policy just kept right on growing. A worst case scenario and it still did well.
I tried the same thing with an indexed UL. The worst case there is that you over fund the UL up to the MEC limit and then letting it run at a worst case scenario of 1%. Because it is all UL with no term blend, more money goes into the cost of insurance which leaves less cash to accrue at 1%. Since the idea is the build enough cash value to become your own banker, it seems something of a no brainer to use the train that has more cash going into the interest bearing pot at a higher guaranteed rate, dividend paying whole life.
I can hear the screams from my friend already. “But that IUL will do better than 1%. You know that!” OK. Just for a minutes let’s pretend that it does as good as the whole life. Let’s say 5%. That means they both performed better than their guarantee. But you still have more cash going into the interest accruing train with the dividends running at 1/3 of what they are currently paying. Given the same interest rate the whole life wins again.
Bottom line. The thing I don’t like about indexed UL’s is the same thing I didn’t like about universal life in the 80’s. The assumptions aren’t sustainable and people are going to be hurt down the road because of that. If you have any questions or think I’m a nutcase, call or email me directly. Let’s talk.