Pay Yourself Back

In the world of Infinite Banking we often hear agents and others talk about the importance of paying ourselves back. People have a lot of different ways of explaining what that means and these explanations can often be confusing or even misleading.

By the end of this post you should have clarity and understand why you should pay your policy loans back. 

Being a consumer and a seller in business, the grocery store.

In Nelson Nash’s book Becoming Your Own Banker, he compares using your life insurance policy as a bank to operating a grocery store, because in both instances you are the consumer and the seller. He says that the goal of the grocery store owner is to build a business to provide a living for himself and his family, and to ultimately sell the business to fund retirement.

Nelson talks about how it is important for the store owner and his family to pay retail for all of their groceries even though they own the store. He uses the example of a can of peas that retail for $0.60, which the store owner can buy for $0.57. If the store owner’s wife grabs a can of peas and does not pay for them just because it is their family store (It’s my business and I can do whatever I want.), the store must sell 20 cans of peas to make up for the one can of peas the wife did not pay for.

If she keeps doing this think of how much the compounding effect will hurt their business. If this behavior is followed and the family continually doesn’t pay the store for groceries, performance will be hurt and ultimately failure could occur.

Why did we start the whole life policy?

Now let’s think of this in terms of using our whole life policy. Our purpose for starting a policy was to create a place to store and grow capital to finance our needs, capitalize on opportunities, provide income in retirement, and to leave a legacy to our heirs. If we never pay our policy loans back, they grow, and slowly start to deplete our available capital (cash value). 

For example, if you have $100,000 in cash value and take a $90,000 policy loan to purchase a property, your available cash value drops to $10,000.00 and your death benefit drops by $90,000. Your policy still has $100,000 of cash value, $90,000 has just been collaterally assigned to your policy loan.

When we use policy loans to access capital our money stays in the policy and earns interest, while the insurance company lends us their money at an interest rate that accrues at annual simple interest. We can pay that loan back as fast or as slow as we want, or not at all. If we don’t pay it back, the loan balance will keep growing every year, which will continually decrease our cash value and death benefit.

Nelson said, “This is an exercise in IMAGINATION, REASON, LOGIC AND PROPHECY”, “Your behavior in managing the system is the most important factor in the entire equation.”   Nelson would call this, stealing the peas.

Being an honest banker allows you to recapture lost opportunity cost.

We should be honest bankers and pay our loans back. Some people think we are paying interest to ourselves, but when we pay policy loans the interest is actually going to the life insurance company.

Since it is a mutual company, we are part owners and do receive benefits from the interest in the form of dividends, but that interest rate we pay does not directly come back to us. The way whole life policies and policy loans are structured does allow us to recapture lost opportunity cost though, and that is why this concept works (refer to our blog How do I access the money in my policy to see how opportunity cost is recaptured). 

Your behavior in managing the system is the most important piece of building a successful Infinite Banking system.

If we never pay our loans back, we limit the potential of our policies and even run the risk of lapsing our policy.

Our goal should be to act as honest bankers and pay our loans back. After the loan is repaid, we have access to the total cash value and are ready to pursue the next opportunity (loans do not have to be paid back to take on another loan, the ability to take another loan is dependent on the available cash value in your policy). During retirement if we want to use the policy as a passive income source and not repay loans that is completely fine. As long as we have been playing honest banker, we will have the full cash value to receive passive income from, tax free, with a properly structured and implemented plan!