The longer you live, the more likely you are to get caught up in straight-line thinking. Certain areas of your life take on a stale flavor and produce predictable outcomes. For many of us, money management falls into this category. We manage, save, and invest money the same today as we did five, 10, or even 15 years ago. The may have changed, but it’s ultimately the same approach.
If you still believe a bank is the best place to stash your cash and invest your money, you’re falling for one of the great financial myths in American history. Because while banks may keep your money safe, they don’t help you build wealth. If you want to enjoy optimal flexibility, you need to do what the pillars of America’s wealthy and elite – folks like Walt Disney, Ray Croc, John D. Rockefeller, and President John F. Kennedy – have done for decades: Leverage a concept known as cash flow banking to protect and grow wealth.
How Do Banks Make Their Money?
Most people have no gripes about putting their money into a big national bank. These institutions are safe, federally insured, and essentially guarantee that they’ll protect your money. Checking and savings accounts are seen as safe places to stash money. But have you ever thought about what the banks do with your money once they have it?
In some situations, you – the client – actually pay the bank in the form of account fees, transaction fees, and other bogus charges. In other instances, they may turn around and give you a measly interest rate for certain types of accounts, account balances, or transactions. But either way, this is just what’s occurring on the surface level.
Small account fees don’t keep banks in business. If banks were to survive on account fees, overdraft charges, and other expenses of this nature, they’d simply be generating the difference between these charges and the interest they pay out to their clients. It would be a very small profit margin. In fact, after taking overhead expenses into account, most banks would operate in the red. They’d only last a few months before going out of business.
The truth is that banks make their money in another way. Here’s an illustration that shows what they’re really doing:
- You put $20,000 into your bank account. Your bank tells you they’ll wave all fees and even bump you up to a higher than average interest rate – a whopping 1 percent! You’re happy because your money is safe (and earning more than it would be sitting in a coffee can under your bed). The bank, on the other hand, is licking its chops.
- As soon as that $20,000 clears into your account, the bank turns around and offers your money up to other clients who want car loans, personal loans, home equity lines of credit, etc. But here’s the kicker: They charge the borrower 5 percent on the money.
- The difference between what the bank is paying you in interest in your money and what the bank is charging its clients to use your money is referred to as “the spread.” In this case, the spread is 4 percent. The bank is making 4 percent for the privilege of letting other people borrow your money. And they continue to do it over and over again – typically making at least five-times the spread by using it again and again.
There’s nothing wrong, immoral, or unethical about what the banks are doing. Anyone who is familiar with banking business models and lending knows what’s happening. The problem is that the average American banking client isn’t aware of what’s happening. And even if they are aware, they don’t see any other viable opportunity.
But what if there were a way for you to act as your own bank? What if you could keep your money safe, earn interest, and leverage it for cost-effective financing without hurting your underlying investment? Well, perhaps you can. This is what cash flow banking is all about – and we’re about to explore it in further detail.
What is Cash Flow Banking?
Infinite Banking, Bank on Yourself, Become Your Own Banker, the Private Reserve Strategy – it’s been given a lot of names over the years, but we’ll simply refer to it as “cash flow banking.”
The basic premise of cash flow banking is that most people, over the course of many decades, give away a large portion of their individual wealth to creditors via interest payments. Whether it’s car loans, home mortgages, credit cards, or student loans, money pours out of your accounts and makes other people wealthy.
But it’s not just the lost interest that sets you back. It’s actually the lost interest on that interest, too! It’s a negatively compounding effect that prevents people from building meaningful wealth for themselves and their heirs.
What if, rather than letting banks use your money to generate massive spreads, you could actually leverage your own money via a strategic life insurance policy that allows you to fund purchases and pay the policy back without ever touching the cash value of the policy?
Furthermore, because you own a life insurance policy, you enjoy all of the other perks that come with having a whole life policy This includes a guaranteed tax-free death benefit for your heirs; a cash value that’s guaranteed to grow; tax-free growth, withdrawals, and loans; and possibly even annual dividend payments (which accelerates growth even more).
Not all whole life insurance policies can be used in a cash flow banking system. In order to understand which policies work and which ones don’t, you have to be familiar with the concept of “direct recognition.”
When life insurance companies use direct recognition, they choose only to pay dividends on the cash value that’s left in the policy after all loans are taken out. Thus if you have a $50,000 cash value and you borrow $25,000 against the policy, the insurance company only pays dividends on the $25,000 you have left over.
But not all life insurance companies practice direct recognition. Some are structured in such a way that they don’t stop paying dividends on the money you’ve borrowed against. They continue to pay on the full cash value of the policy.
How could that be, you may ask? Well, you have to understand that you aren’t actually borrowing the cash value of your own policy. What you’re doing is borrowing from the life insurance company’s general fund – using the cash value in your policy as collateral. This allows your money to stay in your account, where it continues to earn interest, dividends, and all of the other benefits.
With whole life insurance policies that don’t practice direct recognition, you effectively lower the interest rate that you pay on loans drawn against your policy. So while you may pay 7 percent on the loan, a dividend rate of 5 percent lowers your cost of capital to just 2 percent.
The Pros of Cash Flow Banking
While it’s hard to grasp all of the details of cash flow banking in a single sitting, you now have enough information to understand the basic gist of it. Now let’s explore some of the specific advantages this strategy yields:
- Cheap financing. As mentioned above, non-direct recognition policies allow you to borrow money very inexpensively. In good years where dividends are higher than average, you may even gain access to free money.
- No approvals. Because you already have the cash value in your policy, you don’t have to file an application or run a credit check. You can often gain access to cash within 24 hours or less.
- Tax-free access. Unlike a traditional IRA, which requires you to pay income tax on the funds you withdraw (and charges steep fees for early withdrawals), whole life policies provide tax-free access at any time.
- No payback requirements. Want to know something interesting? You don’t even have to pay back the loan if you don’t want to. While it’s recommended that you do, any outstanding loan balance will simply be subtracted from the death benefit upon payout.
- Asset protection. Whole life insurance policies are great for protecting cash and assets. Should you be sued or caught up in a legal dispute, the value of your policy is typically off limits.
- Death benefit. Not only do you get all of these benefits, but you also enjoy the peace of mind of a life insurance policy with a death benefit after you die.
The Cons of Cash Flow Banking
If this is your first time discovering cash flow banking, you’re probably thinking it sounds too good to be true. And though cash flow banking is beautiful when it works – it’s not a perfect solution for everybody in every situation. There are some downsides, negatives, and risks to be aware of. Let’s take a look:
- Qualifications. Not everyone can become their own bank through the cash flow banking system. Because we’re dealing with life insurance, there are requirements for who can purchase a policy. If you have a disease, chronic health condition, or other mitigating factors, you could be deemed ineligible.
- Expensive. Whole life insurance is significantly more expensive than other types of insurance. Depending on your age and health condition, it could be cost-prohibitive for you and your family.
- Takes time. Whole life insurance policies don’t accumulate massive amounts of cash value overnight. It typically requires eight to ten years of premium payments before you see any sizeable growth. Depending on how much you’re putting in, it could take 20-plus years before it can be leveraged.
- Contribution requirements. With a retirement account like an IRA or 401(k), you’re in charge of how much you contribute and when. If you lose your job and don’t have an income for six months, you can simply stop contributions and wait until you’re financially capable of investing money again. With a whole life insurance policy, contributions are compulsory. If you don’t make premium payments, your policy could lapse.
Who is a Good Fit for Cash Flow Banking?
Cash flow banking is ideal for individuals who are already financially secure. You need to be capable of making premium payments and funding a policy without negatively impacting your month-to-month finances. It’s generally recommended that you put at least 10 percent of your income into a whole life policy each month. If you can’t do this, cash flow banking might not be the best option.
Individuals with less financial security are typically better off investing in an employer-sponsored 401(k) and purchasing cheap term life insurance instead. But as always, it’s wise to speak with a financial planner to figure out the ideal course of action for you and your household.
Getting Started With Cash Flow Banking
The benefits of cash flow banking are clear. The disadvantages and potential risks are also easy to see and understand. You’re either a good fit for this strategy, or you’re not. If it’s something that looks like it could benefit you, it would be wise to get the ball rolling sooner rather than later.
Unless you have a professional background in insurance and understand the ins and outs of how to study policies and know how they work, cash flow banking isn’t something you want to get involved with on your own. Your average run-of-the-mill insurance agent isn’t in the business of helping clients set up cash flow banking systems. They’re focused on selling policies at a large volume to turn a nice profit. And while they’ll gladly sell you a whole life policy whenever you want one, they might not structure it correctly.
The best approach is to work with a financial planner or advisor who understands cash flow banking and has helped clients set up similar systems before. They’ll walk you through the numbers, show you where to purchase the right type of policy, and ensure you understand how to properly leverage your money over time.
Cash flow banking isn’t the simplest concept to grasp, but it works. If it’s good enough for American royalty like the Rockefellers and Kennedys, it’s probably good enough for you!