Infinite Banking in Canada: A Balanced Look at the Benefits, Risks, and Alternatives

In the realm of personal finance and wealth-building strategies, few concepts have generated as much buzz and debate as infinite banking. Promoted as a revolutionary approach to financial independence, it promises a pathway to self-financed loans, tax-advantaged growth, and a lasting legacy for your loved ones.

But what exactly is infinite banking? And does the reality live up to the hype, especially in the Canadian context?

At its core, infinite banking is a strategy that leverages the cash value component of a whole life insurance policy. Instead of relying on traditional banks for loans, proponents of infinite banking argue that you can “become your own banker” by borrowing against the cash value of your policy. This, they claim, allows you to control your finances, access capital on your terms, and build wealth over time.

Sounds enticing, right? But before you embrace this financial strategy, it’s crucial to understand how it works in Canada, where tax laws and financial regulations differ significantly from those in the United States. It’s equally important to weigh the potential benefits against the risks and consider whether alternative strategies might be a better fit for your financial goals.

In this comprehensive guide, we’ll examine the intricacies of infinite banking in Canada. We’ll explore how it works, investigate its potential advantages and disadvantages, compare it to other financial tools, and help you decide if it’s the right path for you. Whether you’re a seasoned investor or a curious newcomer, this article will equip you with the knowledge and insights you need to make informed financial decisions.

At Taxevity, our mission is to provide balanced, unbiased advice, empowering you to navigate the complex world of personal finance with confidence. Let’s get started and uncover the truth about infinite banking in Canada.

How Infinite Banking Works (In Theory)

To grasp the allure of infinite banking, it’s essential to understand the underlying mechanics of a whole life insurance policy. Unlike term life insurance, which only provides a death benefit for a specified period, cash value life insurance combines a death benefit with a cash value component that grows over time.

As illustrated in the infographic above, the cash value accumulated within a whole life insurance policy serves as the foundation for infinite banking. In essence, you become your own banker, borrowing against this cash value to fund various financial goals. Let’s look deeper.

There are two forms of cash value life insurance:

• Whole Life (WL): These policies are known for having no investment choices (everything is handled by the insurer). They offer some level of guaranteed cash value growth on top of non-guaranteed policy dividends. Investment gains and losses are spread out over a number of years, which is called “smoothing”. This reduces volatility. They typically come with higher premiums compared to other types of life insurance, with limited to no flexibility if a payment cannot be made. 
• Universal Life (UL): These policies offer a great deal of flexibility in premium payments and investment selection, but their cash value growth isn’t guaranteed and may be subject to investment risk. There is no smoothing. UL policies can be a practical option for individuals who want more control and flexibility, or who have fluctuating incomes.

Infinite banking tends to use whole life insurance in Canada, as in the US.

The Role of Policy Loans

The cash value accumulation within a whole life policy is a key feature of infinite banking. It stems from a portion of your premiums being invested by the insurance company, typically in a mix of conservative assets like bonds and mortgages. As the cash value grows, it can be accessed through policy loans offered by the insurance company. Interest rates may be lower compared to traditional bank loans. 

This model is often touted as a way to control your financial destiny, providing access to capital for various purposes, such as:

• Purchasing assets: Real estate, businesses, or other investments
• Funding education: Covering tuition costs for yourself or your children
• Paying off debt: Consolidating high-interest debt or paying off a mortgage
• Supplementing retirement income: Creating a tax-advantaged income stream

In theory, the cash value in your policy continues to grow tax-deferred, even while you’re borrowing against it. This creates the potential for significant wealth accumulation over time, especially if the policy’s dividends perform well. However, it’s important to note that policy loans do accrue interest, and the interest rate can vary depending on the insurer and policy type. There are other considerations listed below.

Collateral Loans vs. Policy Loans

While policy loans are central to the traditional infinite banking concept, another option commonly used, particularly in the high-net-worth (HNW) market, is using your whole life insurance policy as collateral for loans from external lenders. This approach, known as a collateral loan, involves assigning your insurance policy to the lender as security for the loan.

• How they work:
  • Policy Loans: You borrow directly against your policy’s cash value from the insurance company. Interest is paid back to the insurer.
  • Collateral Loans: You use your policy as collateral to secure a loan from a bank or other financial institution.
• Advantages and disadvantages:
  • Policy Loans:
    • Pros: Easy to access, no additional underwriting required.
    • Cons: Limited by the policy’s available cash value, potential tax implications if loans exceed the adjusted cost basis (ACB).
  • Collateral Loans:
    • Pros: Potential for lower interest rates, no restrictions on the use of funds.
    • Cons: Requires pledging your policy as collateral, stricter qualification requirements.
• Different use cases (leveraging, investing, spending): Both loan types can be used for various purposes, such as leveraging investments, funding expenses, or diversifying assets.

The choice between collateral loans and policy loans depends on your individual circumstances, financial goals, and risk tolerance. Taxevity can help you assess the pros and cons of each option and determine the best approach for your specific needs.

The Canadian Reality Check: Policy Loan Taxation and Policyowner Dividends

While the theoretical principles of infinite banking may seem appealing, it’s crucial to understand how they translate to the Canadian context, where tax laws and financial regulations can significantly impact the strategy’s effectiveness.

Policy Loan Taxation and the Adjusted Cost Basis (ACB)

One of the most significant differences between infinite banking in Canada and the United States is the taxation of policy loans. In Canada, any portion of a policy loan that exceeds your policy’s adjusted cost basis (ACB) is considered taxable income.

The ACB is essentially the cumulative premiums you’ve paid into the policy minus the cumulative Net Cost of Pure Insurance (NCPI). Policy loans reduce the ACB, and repayments increase it. As the years pass, the ACB will eventually reach zero, at which point the entire policy loan becomes taxable income.

This is a crucial point to consider when evaluating infinite banking in Canada, as it can significantly impact your overall returns and financial planning.

The Role of Policyowner Dividends in Policy Performance 

Another key aspect to understand is the role of policyowner dividends in the performance of whole life insurance policies. Many whole life policies in Canada are participating, meaning they pay dividends to policyholders based on the financial performance of the participating (par) account.

These dividends can play a significant role in the growth of your policy’s cash value and overall returns. However, it’s important to remember that dividends are not guaranteed and can fluctuate from year to year, depending on the insurer’s profitability and investment performance.

When considering infinite banking, it’s essential to assess the historical dividend performance of the insurer and understand how potential fluctuations could impact your policy’s cash value growth and your ability to borrow against it. It’s also important to note that the formulas used to calculate policyowner dividends are not typically disclosed by insurers.

Comparing Participating and Non-Participating Policies 

• Participating Policies: Offer the potential for higher returns through dividends, but also carry the risk of dividend fluctuations. The formulas used to calculate dividends are generally not transparent.
• Non-Participating Policies: Provide guaranteed cash value growth, with formulas often explicitly linked to non-guaranteed investment returns. While they may offer lower potential returns than participating policies, they provide more predictability by being more transparent and by usually being less sensitive to decreases in returns than participating policies.

In the long run, it’s difficult to say definitively whether par or non-par policies will perform better, as future investment returns are uncertain. The best choice for you will depend on your risk tolerance and financial goals.

Mutual vs. Shareholder-Owned Companies: A Closer Look at Ownership and Profit Distribution

When considering infinite banking, the type of insurance company you choose can play a significant role in your experience. Two primary types of insurance companies exist: mutual companies and shareholder-owned companies. Each has a distinct ownership structure and approach to profit distribution, which can impact the performance of your whole life policy and your overall experience with infinite banking.

Mutual Companies

• Ownership Structure: Mutual companies are owned by their policyholders. In theory, this means that profits generated by the company are shared among the policyholders, often in the form of policyowner dividends.
• Profit Distribution (In Theory): This ownership structure can be appealing to proponents of infinite banking, as it creates the perception that you’re “borrowing from yourself” when taking out policy loans. However, the reality of profit distribution in mutual companies is more nuanced.
• The Reality of Profit Distribution: Dividends in mutual companies are not distributed equally among all policyholders. The amount you receive can vary based on factors like the size of your policy, the duration you’ve held it, and the company’s overall financial performance. Moreover, the formulas used to calculate these dividends are typically not transparent, making it difficult to predict future payouts.

Shareholder-Owned Companies

• Ownership Structure: Shareholder-owned companies are owned by shareholders, who invest in the company and expect a return on their investment. Profits generated by the company are typically distributed to shareholders in the form of dividends.
• Profit Distribution: While shareholder-owned companies may not offer the same appeal of “ownership” as mutual companies, they can still provide competitive whole life insurance policies, including participating policies with dividends.

Par and Non-Par Policies in Both Types of Companies

It’s important to note that both mutual and shareholder-owned companies can offer both participating (par) and non-participating (non-par) whole life insurance policies. The type of policy you choose should be based on your individual financial goals, risk tolerance, and the competitiveness of the product, rather than solely on the company’s ownership structure.

The Demutualization of Major Canadian Insurers

In the late 1990s and early 2000s, the biggest Canadian life insurance companies, including Canada Life, Industrial Alliance, Manulife, Mutual Life (which became Clarica), and Sun Life, demutualized. This means they converted from mutual companies owned by policyholders to publicly traded companies owned by shareholders. These companies have generally thrived since demutualization, with increased access to capital, improved innovation, and enhanced competitiveness.

Key Considerations When Choosing an Insurance Company

• Financial Strength and Stability: Choose a company with a strong track record of financial stability and a good rating from independent rating agencies.
• Product Offerings: Compare the features, benefits, and costs of different policies from various insurers to find the one that best suits your needs.
• Customer Service: Look for a company with a reputation for excellent customer service.
• Ownership Structure: While the ownership structure is a factor to consider, it should not be the sole determining factor in your decision. Focus on the overall value and suitability of the policy for your financial goals.

By carefully evaluating these factors, you can choose an insurance company and policy that aligns with your individual needs and objectives, regardless of whether it’s a mutual or shareholder-owned company.

While the choice between par and non-par policies depends on individual preferences and financial goals, it’s crucial to weigh the overall benefits and risks of infinite banking before making a decision.

Potential Benefits of Infinite Banking (Under the Right Circumstances)

While it’s important to be aware of the complexities and potential drawbacks of infinite banking in Canada, it’s equally important to acknowledge the potential benefits this strategy can offer under the right circumstances. Let’s explore some of the key advantages that have drawn individuals and businesses to infinite banking:

1. Tax-Deferred Growth

One of the most attractive aspects of infinite banking is the potential for tax-deferred growth within a whole life insurance policy. As your policy’s cash value accumulates over time, it grows on a tax-deferred basis, meaning you don’t pay taxes on the growth unless you withdraw it. This can be a significant advantage for long-term savings goals, as it allows your money to compound over time without being eroded by taxes.

2. Control and Flexibility

Infinite banking proponents often highlight the control and flexibility it offers compared to traditional unsecured loans. By accessing your policy’s cash value through policy loans, you can bypass traditional lenders and their approval processes. This can be particularly appealing to entrepreneurs and business owners who need quick access to capital for investments or operational expenses.

Furthermore, infinite banking allows you to structure your loans on your own terms, with flexible repayment schedules. While policy loan interest rates may be higher than those on secured loans like HELOCs, the ease of access and flexibility can be attractive to some borrowers.

In the later years of a policy, when the adjusted cost base (ACB) has been reduced to zero, collateral loans can instead provide a tax-free way to access the cash value of your policy. This is because collateral loans are secured by the policy itself, and the lender assumes the risk, not the insurance company.

3. Potential for Wealth Transfer

Another potential benefit of infinite banking is the ability to create a lasting legacy for your beneficiaries. The death benefit of a whole life insurance policy, including the accumulated cash value, can be passed on to your beneficiaries tax-free, providing them with a valuable asset to help them achieve their own financial goals.

Important Considerations

While these potential benefits are enticing, it’s crucial to remember that they are not guaranteed and depend on various factors, including:

• The Performance of Your Policy: The growth of your cash value and the amount of policy loans or collateral loans you can access will depend on the specific terms of your policy, the insurer’s financial performance, and the overall economic climate.
• Your Financial Goals and Risk Tolerance: Infinite banking may not be suitable for everyone. It’s essential to assess your individual needs, risk tolerance, and financial goals before deciding if it’s the right strategy for you.
• Tax Implications: As discussed earlier, policy loans in Canada can have tax implications if they exceed your policy’s adjusted cost base (ACB). It’s crucial to understand these tax implications and factor them into your financial planning.

By carefully considering these factors and consulting Taxevity, you can make an informed decision about whether infinite banking is a suitable strategy to help you achieve your financial goals.

Risks and Drawbacks to Consider

While infinite banking may offer potential benefits, start with a realistic understanding of the risks and limitations. Carefully consider the following drawbacks:

1. Complexity and Potential for Mismanagement

Infinite banking is not a simple set-it-and-forget-it strategy. It involves complex financial instruments and requires careful planning and management to maximize potential benefits. Without proper guidance, mistakes can easily erode a policy’s cash value or trigger unintended tax consequences.

2. Surrender Charges

If you decide to surrender or cancel your policy, you may face substantial surrender charges and tax, which can significantly reduce the amount of cash value you receive back. Since owning whole life insurance is a long-term commitment, be sure you’re comfortable with the ongoing costs before proceeding.

3. Over-Borrowing Risks

While policy loans can provide access to capital, it’s crucial to exercise caution and avoid over-borrowing. Taking out too many loans against your policy’s cash value can deplete the post-repayment death benefit significantly, potentially undermining the long-term benefits of infinite banking.

4. The Role of Insurance Company Dividends (and Their Uncertainties)

While policyowner dividends can enhance the growth of your policy’s cash value, they are not guaranteed. Dividend rates can fluctuate based on the insurer’s financial performance and investment returns. It’s important to consider this variability when projecting your policy’s future cash value and potential returns.

By carefully considering these risks and drawbacks, you can make a more informed decision about whether infinite banking is the right fit for your financial goals and risk tolerance.

5. Inflexibility of premiums

With most whole life products, the premiums you deposit are fixed and must be paid or else there will be significant penalties. Either the policy will lapse, or the death benefit will need to be reduced to pay a lower amount (and usually cannot be increased again without full underwriting). It’s important to make sure the payment period (generally 10 years, 20 years, or for life), and premium amount are manageable for you. 

Alternatives to Infinite Banking

While infinite banking may be a suitable strategy for some, it’s not the only option available for achieving your financial goals. Several alternatives offer similar benefits with potentially lower costs, greater flexibility, or simpler execution. Let’s explore some of the most common alternatives to infinite banking. Here is a comparison table:

Now let’s look at each alternative in more detail.

1. Home Equity Line of Credit (HELOC)

A HELOC is a revolving line of credit secured by your home equity. It provides easy access to funds as needed, with flexible repayment options.

• Benefits:
  • Flexibility and Accessibility: Draw funds as needed and repay on your own schedule.
  • Lower Interest Rates: Typically offer lower rates than policy loans.
  • Tax Considerations: Interest may be tax-deductible if used for investment purposes (consult a tax professional).

2. Tax-Free Savings Accounts (TFSAs)

TFSAs are a popular investment vehicle in Canada, offering tax-free growth on your investments.

• Benefits:
  • Tax-Advantaged Growth: Investment income, dividends, and capital gains are tax-free.
  • Flexibility: Invest in a wide range of assets like stocks, bonds, and ETFs.
  • Contribution Limits: Annual limits, with unused room carrying over.

3. Registered Retirement Savings Plans (RRSPs)

RRSPs are designed for retirement savings, providing tax benefits for contributions and deferred growth.

• Benefits:
  • Tax Deductions: Contributions are tax-deductible, reducing taxable income.
  • Tax-Deferred Growth: Investments grow tax-free until withdrawn in retirement.
  • Contribution Limits: Annual limits based on your income.

4. Life Insurance for Protection

While whole life insurance is the cornerstone of infinite banking, life insurance can also be used solely for life-long protection. Term life insurance, for instance, provides a death benefit for a specified period at a much lower cost than whole life.

• Benefits:
  • Affordability: Lower premiums compared to whole life insurance.
  • Simplicity: Easier to understand and manage than complex whole life policies.
  • Conversion: Option to convert to whole life later, regardless of your health.

5. Other Investment Options

Beyond registered accounts and life insurance, a wide array of investment options exists, each with its own risk-return profile and tax implications.

• Benefits:
  • Diversification: Spread your investments across different asset classes to manage risk.
  • Potential for Higher Returns: Some investments, like stocks or real estate, may offer higher potential returns than the cash value growth of a whole life policy.
  • Liquidity: Some investments can be easily sold if you need access to your funds.

Choosing the Right Alternative

The best alternative to infinite banking for you will depend on your individual circumstances, financial goals, and risk tolerance. Consider factors such as:

• Time Horizon: How long do you plan to invest?
• Risk Tolerance: How much risk are you comfortable taking?
• Investment Goals: What are you hoping to achieve with your investments?
• Tax Considerations: What are the tax implications of different investment options?

Taxevity can Help:

At Taxevity, we understand the complexities of personal finance and the importance of making informed decisions. Our team of experts can help you explore all your options, including infinite banking and its alternatives, to create a financial plan that aligns with your goals and values.

Who Might Benefit from Infinite Banking (And Who Might Not):

Infinite banking is not a one-size-fits-all solution. The suitability depends on individual circumstances, financial goals, and risk tolerance. Let’s explore who might benefit from this strategy and who might find it less advantageous:

Potential Candidates for Infinite Banking:

• High-Net-Worth Individuals (HNWIs): Individuals with substantial assets may find infinite banking appealing for its potential tax-deferred growth and wealth transfer benefits. Permanent life insurance helps optimize tax strategies and create a legacy for beneficiaries.
• Business Owners: Entrepreneurs and business owners who value flexibility and control over their finances may find infinite banking useful for accessing capital, managing cash flow, or funding key person insurance. Loans used to invest are generally called an Immediate Financing Arrangement (IFA) in Canada. Learn more about infinite banking for businesses.
• Individuals and Families Seeking Long-Term Financial Security: Those with a long-term perspective and a focus on building wealth over time may find the forced savings and potential for tax-deferred growth appealing. Learn more about infinite banking for personal and family wealth.

Who Might Not Benefit from Infinite Banking:

• Individuals with Limited Resources: The high upfront costs and long-term commitment associated with whole life insurance policies may not be suitable for those with limited financial resources or who prioritize short-term liquidity.
• Risk-Averse Investors: Infinite banking involves some degree of risk, as policy loan interest rates and dividend payouts can fluctuate. Individuals with a low risk tolerance may prefer more stable and predictable investment options.
• Those Seeking Immediate Returns: Infinite banking is a long-term strategy that requires patience and discipline. Those seeking quick returns or short-term gains may find it less appealing.

Important Considerations:

Before embarking on infinite banking, ask yourself the following questions:

• Am I comfortable with the long-term commitment and potential risks involved?
• Do I have the financial resources to maintain the policy and pay the premiums?
• Am I willing to work with a qualified advisor to navigate the complexities of infinite banking?
• Are there alternative strategies that might be more suitable for my financial goals and risk tolerance?

By honestly assessing your individual circumstances and needs, you can determine whether infinite banking aligns with your financial objectives and overall risk profile.

Making an Informed Decision: Your Path to Financial Clarity

As with any financial strategy, deciding whether infinite banking is right for you requires careful consideration and a thorough understanding of your unique circumstances and goals. To navigate this decision-making process effectively, follow these essential steps:

1. Consult with Taxevity

Our family team at Taxevity can provide personalized advice based on your specific financial situation, risk tolerance, and goals. We’ll help you assess the potential benefits and drawbacks of infinite banking.

2. Compare Policies and Insurers

Don’t settle for the first whole life insurance policy you come across. It’s crucial to compare policies from different insurers, considering factors like:

• Premiums: What are the costs associated with the policy?
• Cash Value Growth: How quickly does the cash value accumulate?
• Policy Loan Interest Rates: What are the terms and conditions for borrowing against your policy?
• Dividend History: If it’s a participating policy, what has the insurer’s dividend performance been like in the past?
• Company Strength and Reputation: Is the insurer financially stable and reputable?

By comparing different options, you can find the policy that best suits your needs and budget.

3. Understand the Fine Print

Before committing to any whole life insurance policy, read the fine print carefully and ask questions to clarify any uncertainties. Ensure you understand the terms and conditions of the policy, including surrender charges, policy loan provisions, and dividend policies. Don’t hesitate to seek clarification from your advisor or the insurer’s customer service team.

Frequently Asked Questions (FAQ):

To help address common questions and concerns about infinite banking in Canada, we’ve compiled a list of frequently asked questions:

1. Is infinite banking legal in Canada?

Yes, infinite banking is legal in Canada. However, it’s important to understand the Canadian tax laws and regulations that apply to policy loans and withdrawals.

2. What type of life insurance policy is used for infinite banking?

Whole life insurance policies are typically used for infinite banking due to their reasonably predictable cash value component and potential for policy loans.

3. Can I use any whole life insurance policy for infinite banking?

While any whole life policy technically has a cash value component, not all policies are created equal. Some policies are better suited for infinite banking than others, depending on factors like cash value growth rates, dividend performance, and loan provisions. 

4. How much does infinite banking cost?

The cost of infinite banking depends on various factors, including the type of policy you choose, the amount of coverage, your age, health, and lifestyle. Loan rates vary.

5. Are there any tax benefits to infinite banking?

The cash value within a whole life insurance policy grows tax-deferred, meaning you don’t pay taxes on the growth until you withdraw it. However, policy loans in Canada can have tax implications if they exceed your policy’s adjusted cost basis (ACB).

6. Is infinite banking a good investment?

Infinite banking is not a traditional investment in the sense of stocks or bonds. It’s a financial strategy that combines life insurance coverage with the potential for cash value growth and access to loans. Whether it’s a good “investment” depends on your individual financial goals and risk tolerance.

7. What are the risks of infinite banking?

Some risks of infinite banking include high upfront costs, surrender charges, the potential for over-borrowing, tax implications on policy loans, and the uncertainty of dividend payouts. It’s important to carefully weigh these risks against the potential benefits before deciding if infinite banking is right for you.

8. What are some alternatives to infinite banking?

Several alternatives to infinite banking exist, including home equity lines of credit (HELOCs), Tax-Free Savings Accounts (TFSAs), Registered Retirement Savings Plans (RRSPs), and other investment options like stocks, bonds, and real estate. Each option has advantages and disadvantages, and the best choice for you will depend on your individual circumstances and goals.

9. How can Taxevity help me with infinite banking?

Taxevity can provide expert guidance on all aspects of infinite banking, including policy selection, loan strategies, tax implications, and alternative options. We’ll help you assess the suitability of infinite banking for your financial situation and develop a personalized plan to achieve your goals.

We hope this FAQ has addressed some of your questions and concerns about infinite banking in Canada. If you have any further questions, please don’t hesitate to contact Taxevity for personalized advice and guidance.

Conclusion: Infinite Banking as a Tool, Not a Magic Pill

Infinite banking, like any financial strategy, is a tool that can be used effectively in the right hands and for the right purposes. It’s not a guaranteed path to riches, nor is it a one-size-fits-all solution for everyone.

As we’ve explored throughout this article, infinite banking in Canada presents a complex landscape with unique tax considerations and potential risks that must be carefully weighed against its potential benefits. It’s essential to approach this strategy with a clear understanding of its complexities and a realistic assessment of your own financial goals and risk tolerance.

By approaching infinite banking with a critical and informed mindset, you can make the best decision for your financial future. Remember, infinite banking is just one tool in the toolbox of personal finance. The key is to choose the tools that best suit your individual needs and goals.

At Taxevity, we’re committed to empowering you with the knowledge and resources you need to make sound financial decisions. Whether you choose infinite banking, an alternative strategy, or a combination of approaches, we’re here to support you on your journey to financial well-being.

Promod Sharma (FSA, FCIA, FEA) and Jeevan Sharma (CFP) YOUR FAMILY TEAM

At Taxevity Insurance, we’re passionate about bringing clarity to complex financial decisions. Let us empower you with personalized strategies to achieve your goals. We focus on life and health insurance solutions to protect your business, your family, and your legacy.