Smart Money Podcast: Unlock Life Insurance Secrets: Investing, Variable Policies, and Financial Growth

Explore life insurance as an investment tool, understand variable and infinite banking, and navigate complex insurance choices.

What’s the right life insurance policy for you? What is “infinite banking” and how hard is it to set up? Hosts Sean Pyles and Sara Rathner discuss the intricacies of life insurance as both a protective measure and a financial instrument to help you understand its potential for investment and financial growth. NerdWallet insurance pro Lisa Green joins Sean and Sara to explain term life insurance and more complex life insurance options, such as variable life insurance, and the concept of “infinite banking.” They discuss the nuances of investing extra money into the cash value of a permanent life insurance policy, highlighting guaranteed interest rates versus market risks, and who might benefit from these types of policies. Additionally, they delve into the infinite banking concept, explaining how it works, the financial discipline it requires, and potential pitfalls. This episode is designed to help listeners navigate their life insurance choices and create a balanced financial plan.

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Welcome to NerdWallet’s Smart Money Podcast, where you send us your money questions and we answer them with the help of our genius Nerds. I’m Sean Pyles.

And I’m Sara Rathner. If you have a money question for the Nerds, call or text us on the Nerd hotline at 901-730-6373. That’s 901-730-NERD. Or email us at [email protected].

Follow us wherever you get your podcasts. And if you like what you hear, leave us a review and tell your friends. We’re back and answering your real-world money questions to help you make smarter financial decisions. This episode’s question comes from James, who sent us an email. Here it is. Hello, Nerds. I got contacted about setting up life insurance as a way of borrowing against myself for investments to grow my money. Besides giving them $10,000 to $20,000 to fund the insurance, what’s the scam? I would be borrowing against my own money and paying myself back interest. Is there a downside besides the cash being locked up and the insurance company collecting interest and fees? James.

To help us answer James’s question on this episode of the podcast, we are joined by NerdWallet insurance pro Lisa Green. Welcome back to Smart Money, Lisa.

Thank you, Sara and Sean, for having me.

Insurance can be a complicated and intimidating topic to those who are newer to it. So Lisa, let’s start by setting some foundations. Our listener, James, is interested in life insurance. And broadly there are two categories of life insurance, term life insurance and permanent life insurance. Can you please start by explaining what each of these is and how they fit into life insurance broadly?

Sure. First of all, all life insurance policies have one thing in common. They are designed to pay out a sum of money to survivors when the insured person dies. Term is the simplest form. It lasts for a specific number of years. If you don’t die during those years, the coverage ends, and no one gets a payout. You can think of this as similar to having an auto insurance policy for a year. If you don’t crash your car, the policy doesn’t pay out. Permanent life insurance, on the other hand, is designed to last your entire life. These policies often mature at an advanced age, like 95 or 120. The primary reason to have life insurance is to replace your income if you die. Now, if you’re like me, your family relies on your paycheck to pay the bills. If that paycheck were suddenly gone, and you still want your family to have food to eat, clothes to wear, and a home to live in, you’ll probably want them to have a payout from your life insurance policy.

So a lot of people have a hard time deciding between term and permanent life insurance. Is one generally better for most people than the other?

Yes. Actually, for most families, term life insurance may be all that you need. Let’s say you buy a 30-year term life insurance policy when you’re young and starting a family. It’s designed to cover you during the working years when you’re the primary breadwinner perhaps. By the time that policy ends, your family may not be relying on your paycheck anymore. Your mortgage is paid off, your kids are grown and out on their own. You have some money in the bank. You just don’t need life insurance anymore.

And when might permanent life insurance be a better idea?

In some cases, people do need permanent life insurance. For example, let’s say you have a child with a disability who will need financial support even after you’re gone. You might want to use life insurance to fund a special needs trust for them, and you might want permanent life insurance for this so that the coverage does not expire in 20 or 30 years. Here’s another example. If paying for your funeral would cause financial hardship for your loved ones, you could consider a small permanent life insurance policy that would cover your final expenses.

And there are a number of different types of permanent life insurance, and this is where life insurance can get especially confusing. Lisa, can you give us a really brief overview of some of the different kinds out there?

Sure. Whole life insurance is the most common type of permanent life insurance, and you may also have heard of some other types like indexed universal or variable life insurance. These have differences in how the policies are funded and how the cash value grows, but they’re all permanent life insurance that are designed to last until you are very, very old. Some of these policies can become very complex and require careful monitoring. I also want to note that not everyone even needs life insurance. The point to keep in mind is that you need life insurance if someone depends on you financially.

That’s a really good point, Lisa. And in general, when it comes to insurance products, they are typically best deployed to help you cover a potential risk that is unlikely to happen, like an untimely death, but could be financially catastrophic to you or your loved ones. One of the big differences between term and permanent life insurance is the cost, with permanent life insurance costing a heck of a lot more than term. How much more are we talking here with permanent?

Yes. People might be surprised at the price difference. Permanent life insurance can be much more expensive than term. For example, let’s look at a 40-year-old applicant for a new life insurance policy. Let’s say that this person is in excellent health, and they want to buy a 20-year term life insurance policy for a $500,000 payout. That policy might cost them about $300 a year. Now, let’s say this same person wants to buy a whole life insurance policy. That might be $6,000 a year. That’s 20 times more expensive than term life, but term versus permanent is not the only factor. For example, if that person above is a smoker for that same term policy, the smoker might pay $1,300 a year compared to the $300 for the non-smoker. So that’s already more than four times the rate of the person who’s in excellent health and doesn’t smoke.

If you’ve been smoking and thinking about quitting, let this be one more reason to do so. One of many. So going back to insurance, of course, what goes into these rates, and how can people use this information to compare policies and shop around?

Oh, lots of factors go into setting life insurance rates. Here’s just a few examples. First of all, your age, and this makes sense. Somebody who’s 70 years old is quite a bit more likely to die in the next 20 years than someone who’s 30 years old. So that 70-year-old is going to pay higher rates than the 30-year-old. Your sex is another issue. Women tend to pay less than men because men tend to die sooner. Your health can be a big issue. If you have a preexisting condition or even a family health condition that runs in your family, that could cause you to have to pay higher rates. And your lifestyle and habits can also be an issue. We mentioned smoking a moment ago. Other habits could be a risky hobby, like skydiving or even having a dangerous job. Those could raise your rates as well. So it’s sometimes tough to compare the cost of term versus permanent life insurance because some types of permanent life insurance have flexible premiums where you get to decide within limits how much you want to pay in. But overall, permanent life insurance is more expensive than term for several reasons. First of all, it lasts longer. That means it’s more likely to pay out. The insurance company is more likely to have to pay money on you, and also it may build cash value. Part of the premium that you pay can go into building a cash value that you could in the future perhaps consider borrowing against.

Now that brings me back to James’s question because they seem interested in a form of life insurance that lets you borrow against the amount that you pay into it. And this could be something like a regular whole life insurance product or even a universal whole life insurance product. And these forms of life insurance can get a little complicated since there is the regular life insurance component that we just discussed and people are generally familiar with. But then you can also use it as a savings or maybe even also an investment account of sorts, and there’s what’s known as the cash value component. So Lisa, can you describe how this cash value component works?

Absolutely. When you buy a term life insurance policy, what you pay in premiums is to cover the cost of insuring your life. Sure, there are some administrative costs because the people who work for the insurance company have to be paid, but for the most part, you’re paying for pure insurance coverage. Term life insurance would not work for what James has in mind because it doesn’t build up any cash value to borrow against. Permanent life insurance is different. It has higher premiums, and part of the premium pays for the cost of insuring your life. The other part of the premium goes into building cash value. You can think of cash value as being similar to a savings account. Every time you pay your premium, some of it is saved. Your cash value grows slowly over time from the money you pay in and also from the amount that that money can earn. There’s different types of permanent life insurance because there are different ways to earn money on that cash value. Some policies, like whole life insurance, pay a guaranteed rate of interest. Other policies may pay based on the performance of specific investment options that you choose. And then when the cash value has grown enough, you can borrow against it. But keep in mind it can take 10 or 15 years or even longer to build up enough cash value to borrow against.

So I think we’re starting to see now why life insurance products can be a little confusing for people. Can you give us an example of what one of these policies might look like in practice?

I have a personal example I can share of putting extra money into cash value. I have a small permanent life insurance policy that my parents bought on me when I was a child. Interest rates were higher back then, and so this policy was guaranteed to pay interest of at least 4%. Now, you probably remember a few years ago when interest rates were so low that if you put your money in the bank, you could only get 0.00000001% interest on it. Okay, that’s a little bit of an exaggeration, but yields were very low. So I put some money into the cash value of my life insurance policy, where it would earn 4%. Recently, I took a look at how that policy had performed over the past couple of years, and here’s what I found. I did earn 4% interest on my cash value. One year, I also got a small refund. But remember the cost of insurance over those couple of years, several hundred dollars went to pay for the cost of insuring my life. That money is not in the cash value anymore. So after removing that from the equation, I was left with a return of about 2.5% a year on the money that I put into the policy.

So now in the end, do you think it was actually a good return on your investment?

Depends on what you compare it to. It’s better than that teeny tiny return that I would’ve gotten by putting the money in a bank account. Of course, interest rates have risen since then. Right now, I could go get a 5% certificate of deposit at a local bank. So the life insurance policy is not as good of a deal now as it was back then. So what if I had put the money into a mutual fund instead, let’s say an S&P 500 index fund? I ran those numbers, and I saw that I really would’ve come out ahead, mostly because of not paying the cost of insurance. The expense ratios on an index fund are typically a lot lower than the cost of life insurance, but I also would’ve risked losing money if the market declined, which it did for part of that time.

We’ll be back in just a moment. Stay with us. So Lisa, some consumers can get a little bit excited when they hear about these new and novel types of life insurance policies because they can seem like a secret way to stash cash or invest through a life insurance policy. But these products are not simple, and they are not great for everyone, I would maybe even say most people. So who do you think might be a good candidate for something like this?

Variable life insurance is one way that some people use to achieve their investment goals. It is permanent insurance that combines an investment and an insurance policy. You can allocate its cash value to different investments through subaccounts that are similar to mutual funds. You can choose subaccounts from the options that are presented to you by your insurer. Depending on how those investments perform, your cash value can gain value, or it can lose value. So this type of policy can be very risky. In fact, the federal government requires people who sell variable life insurance policies to be registered to sell securities such as stocks as well as life insurance. That’s a signal that variable insurance is more complex than a standard policy.

So it seems like James might be alluding to this concept, something called infinite banking. Could you explain what that is? Because it sounds completely made up.

Absolutely. The infinite banking idea has been around since the 1980s, and recently it has just really gone viral on TikTok. It involves treating the cash value of a permanent life insurance policy as if it were your own personal bank. Here’s how it typically works. You buy a whole life insurance policy, and you put as much money as you can into its cash value. You keep doing this for several years. It typically takes 10 years or more to build up enough cash value to borrow against. Then you can borrow money against the cash value and repay it so that the cash value continues to grow. You may have heard this described as borrowing from yourself and paying yourself interest. That isn’t exactly what’s happening. You’re borrowing from the insurance company using your cash value as collateral for the loan, and you’re repaying the loan with interest to the insurance company. Your policy does continue to accrue interest during this time according to the terms of your contract, but probably at a lower rate than what you’re paying on the loan. Now, there is an advantage to borrowing against the value of your life insurance. You don’t have to qualify for the loan in the same way that you do for traditional loans. You don’t have to go through an extensive application process to prove your creditworthiness. You can simply request a loan against your cash value and get it regardless of your credit score or other factors. You won’t have access to all of your cash value, though. If you took out all of it out, it would crash your policy, and it would end. And you also have a lot of flexibility in repaying the loan, which is another advantage for some people.

But people should keep in mind that the death benefit, which again is ostensibly the whole point of having life insurance, may be reduced by the loan amount left outstanding if you pass away before you pay off the loan.

Yeah. So this begs the question, who might be a good candidate for a product like this?

For infinite banking, the right candidate would be a person who is very disciplined and willing to put a lot of money into the cash value of their policies year after year. This is not a casual endeavor. You would need to pay a lot of attention to your policies and really make this a lifestyle. I want to share a direct quote from the creator of the infinite banking concept. He was an insurance agent named Nelson Nash, and in his book Becoming Your Own Banker, he said, “It is going to take years to get started, and it needs to be a lifetime commitment.”

That does sound like something an insurance salesperson would say.

Or somebody involved in a multilevel marketing scheme.

Yeah. This gets me to one of my main gripes with life insurance products like this is that people think that they found some secret way to invest or become their own banker. It does feel very in tune with what I see on TikTok a lot. But for most people, there are much simpler and less expensive ways to invest your money or access your own cash, maybe a 401k or just a high-yield savings account. You can access your own money that way without having to wait 10 years to be able to really have enough in there, most likely. And if someone is hyping up one of these insurance products, listener, I would say ask yourself why they might be doing that because it might just be an insurance salesperson looking to make a buck.

So James, with all of that, we’re getting to the core of your question, which is what’s the scam? That’s a great question. You should ask that basically every day. Whenever you receive an email, just ask yourself, “What’s the scam here?” Even if it’s from-

Yeah, especially if it’s about insurance.

Yeah. Even if it’s from your own sibling, just ask what the scam is. So it sounds like they have about $10,000 or $20,000 to put into one of these products. What kinds of fees or other expenses might they face, and what other downsides should they be aware of?

Oh, there are definitely downsides to James’s suggestion of buying life insurance in order to borrow against it. First of all, permanent life insurance is expensive. It can easily cost 10 or 20 times as much as the same amount of term life insurance, and that is basically the minimum payment. People who advocate life insurance as a source to borrow against will encourage you to put in more than the minimum required premium or as much as the policy will allow. For infinite banking, it’s typical to put 10% or more of your take-home pay into your life insurance policy on a continuing basis. That’s a big commitment that many people may not want to make or be able to make. Second, it takes a long time to build up enough cash value to borrow against, often 15 or 20 years. Third, the cost of insurance acts as a drag on the financial performance of a permanent life insurance policy. Part of your premium is used to pay the insurer for the risk that you’ll die, and they’ll have to pay out a death benefit. And fourth, this requires a really high level of financial discipline that can be tough to maintain. Your premiums can be very large, and if you fall behind on paying them, your policy could lapse. And all this assumes that you can get reasonably priced life insurance in the first place.

I really appreciate you sharing all of that, Lisa. So I’d like to hear what would be maybe your bottom line for James or anyone else who’s maybe still at this point considering a product like this?

Yes. James has $10,000 or $20,000 to invest. That’s great. So does James need life insurance? The first question to ask is whether James’s death would have financial repercussions on the people in their life. If the answer is yes, then James should look into life insurance for that reason. Term life insurance may be the most cost-efficient way to do that. Then James may want to consider other financial priorities for that $10,000 or $20,000. Are there student loans or credit cards that need to be paid off? Does James have an emergency savings fund, enough to cover several months of living expenses? And is James setting aside money for retirement? It may make sense to direct 10% or more of income into a tax-advantaged retirement account like a 401k or a Roth IRA before exploring something like infinite banking. If James has this money available to invest, then James is in a position to make some smart financial decisions for the future, and I wish him all the best.

Well, Lisa Green, thank you so much for coming on Smart Money and talking with us about this.

And that’s all we have for this episode. Remember, listener, that we are here for you and your money questions, so send them our way. You can call or text us on the Nerd hotline at 901-730-6373. That’s 901-730-NERD. Or email them to [email protected]. Also, visit nerdwallet.com/podcast for more info on this episode. And remember, you can follow the show on your favorite podcast app, including Spotify, Apple Podcasts, and iHeartRadio to automatically download new episodes. This episode was produced by Tess Vigeland. Sara Brink mixed our audio. And a big thank you to NerdWallet’s editors for all their help.

And here’s our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.