The investment information provided on this page is for educational purposes only. NerdWallet does not provide advisory or brokerage services, and does not recommend or advise investors to buy or sell particular stocks, securities or other investments.
Scroll through TikTok’s money feed and you’ll come across viral videos about “infinite banking”. The concept is causing a stir on social media, fueled by celebrities like rapper Waka Flocka Flame.
But the infinite bank is nothing new. The term was coined by economist Nelson Nash in the 1980s and described in his 2000 book, “Becoming Your Own Banker: Unlock the Infinite Banking Concept”. The strategy is to tap into the cash value of certain life insurance policies like whole life and treat it like a personal bank.
Nash promoted infinite banking as a path to financial freedom and wealth creation. But it’s a bit more complicated than Waka Flocka Flame and TikTokkers claim.
How Infinite Bank Works
Whole life policies generally last your lifetime and have a cash value component that grows at a guaranteed rate over time. That rate of return varies among insurers, but it’s usually around 5%, said Barry Flagg, a licensed life insurer in Tampa, Fla., and founder of life insurance research firm Veralytic, in a E-mail.
Once your policy has built up enough cash value, you can start lending against the funds – and that’s where the concept of ‘betting on yourself’ comes in.
When you pay your life insurance premium, a portion is allocated to the cash value of the policy. Infinite Banking goes one step further: policyholders pay extra money into cash value to accelerate growth. They then treat it like a personal line of credit and borrow against the cash value of the policy to pay for major purchases instead of relying on traditional lenders or dipping into their savings.
But cash value life insurance can be complex and expensive, and infinite banking is a nuanced concept. For these reasons, it’s best suited for wealthy individuals with a high risk tolerance, says Flagg.
Turn your policy into a personal bank
This strategy has advantages. For example, you don’t have to qualify for a cash value loan in the same way as traditional loans. The money in cash value policies is liquid, and there’s no obligation to repay the loan on a specific date — or at all. If you don’t, however, your insurer will subtract the amount you borrowed from the policy’s death benefit, leaving your beneficiaries with a lower payment when you die.
Under the infinite bank, the cash value is a security for the loan and the life insurance policy is tied to it. This means you risk losing your coverage if you don’t monitor the cash value closely. Insurers also charge interest on cash value loans.
“If you were really borrowing from yourself, you wouldn’t be paying yourself interest,” says Daphne Jordan, a certified financial planner and wealth advisor with Pioneer Wealth Management Group, based in Austin, Texas.
In addition, the infinite bank is expensive. For example, a healthy 40-year-old man can expect to pay $7,028 a year on average for a $500,000 whole life insurance policy, according to Quotacy, a life insurance brokerage in line. In most cases, he would pay premiums every year for the rest of his life.
The financial obligations do not stop there. Infinite banking only works when policyholders overfund cash value. For a healthy 40-year-old man, that means contributing money beyond the $7,028 paid in annual premiums. It’s common in infinite banking to allocate around 10% of your earnings to cash value each month, which is no small feat.
Another disadvantage of the infinite bank is time. It can take years or even decades to build up the cash value you need to start taking out loans without penalty.
Think about your priorities
The main purpose of life insurance is to leave money to your loved ones when you die, not to create an estate.
For Jordan, wealth creation is a science, and it starts with taking care of the basics.
Consider paying off debts like student loans and credit cards and building an emergency savings fund. Try opening a high-yield savings account at a bank insured by the Federal Deposit Insurance Corp., or FDIC, or at a credit union backed by the National Credit Union Administration, or NCUA, and save enough money to cover three months of living expenses.
Focusing on your retirement comes next. Jordan recommends directing at least 10% of your income to a tax-efficient retirement account, like a 401(k) or Roth IRA, before exploring something like Infinite Banking.
“When you’re on a plane, they always tell you to put the oxygen mask on yourself before you help others,” says Jordan.
“The way you do that with wealth building is to start saving for the unexpected and start saving for your future self.”
This article was written by NerdWallet and was originally published by The Associated Press.
More from NerdWallet
Katia Iervasi writes for NerdWallet. Email: [email protected].
Infinite Banking article is buzzing on TikTok, but is it for you? originally appeared on NerdWallet.