What is private family banking, and is it right for me?

Having checking and savings accounts are important in securing our financial future. Savings accounts give you a secure spot to save extra cash, and checking accounts do the same but also allow you to access your funds with a debit card. Private family banking is another way families manage their finances through generations.

But what exactly is private family banking, and what are its pros and cons? We cover this and more below.

What is private family banking?

Private family banking isn’t literally setting up your own bank. Instead, it is the act of setting up your finances to reduce the need for traditional banks when it comes to borrowing funds to buy a home, buy a car, pay off debts, and more. It requires a few steps and careful financial planning, but the payoff is not relying on loans from traditional banks to fund various ventures, meaning you skip some of the fees and high interest rates that may come with these loans.

How does family banking work?

Family banking may sound like a wild venture requiring massive cash flow, but it’s not. In fact, just about anyone can start their own private family bank with plenty of research. Let’s explore how it works.

Get a whole life insurance policy

The foundation of private family banking is life insurance. But not just any old life insurance. Only a whole life or universal life insurance policy that builds cash value will work. 

When you purchase a life insurance policy with cash value, the life insurance company guarantees a minimum amount of cash value growth over time. You can then borrow against this cash value to finance important purchases, such as a car, home, or education. You can even borrow to start a business.

On top of the cash value, the whole life insurance policy may pay dividends, which can increase the cash value. But you can use the dividends for other things as well.

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Use dividends to purchase paid-up insurance riders

As you receive dividends, you can use them to purchase paid-up insurance (PUI) riders or paid-up addition (PUA) riders. PUI and PUA riders are the same thing, it’s just that some insurers have different names for them.

You can purchase PUAs with dividends by opting into the paid-up additions dividend option on your whole life insurance policy. This means, as those dividends roll in, you have the option to use those to purchase additional, incremental coverage increases, which also build cash value. 

So, essentially, you’re using cash value to build cash value. This financial strategy is similar to reinvesting stock dividends in the stock market to compound your growth.

Borrow against the cash value to fund projects

Over the years, your whole life insurance policy will build cash value — the money you can borrow or even cash out completely over time. This cash value grows tax-deferred, so you’re only taxed on it if you withdraw it in specific cases, such as making a withdrawal in the first 15 years that reduces the death benefit. 

With cash value available, you can act as your own banker and take out a loan. Loans from the cash value are tax-free, though insurance companies do charge interest rates for these policy loans — typically 5% to 8%.

Continue making premium payments to secure your family’s wealth

The backbone of private family banking is the whole life insurance policy. Not only does it build cash value, acting as a sort of interest-bearing savings account, but it’s also there for future generations.

With the private family bank strategy, the life insurance policy’s death benefit is there to build generational wealth. Your family can then take this lump-sum payment and reinvest it to continue growing the family’s wealth and enjoy a greater sense of financial freedom. And with proper management, this wealth-building can continue in the next generation and all the generations that follow.

What are the potential benefits of building your family bank?

Numerous potential benefits exist when you start your own family bank. Let’s review some of them.

Passing on wealth

Likely the biggest benefit to a family bank is it helps build generational wealth within your family. This is because the basis of this personal finance strategy is a whole life insurance policy with a death benefit. Upon your passing, your family will receive this lump-sum payment that they can then use to continue the family bank and build more wealth.

Borrowing without hurting cash value

When you have a traditional savings account and withdraw cash, you no longer earn interest from the cash you withdrew. This can eat up your ability to build wealth based on compounding interest. However, when you take out a loan on your whole life insurance policy, the insurer will use your cash value as collateral, but the loan does not impact your actual cash value.

This means your cash value remains intact and continues growing and earning dividends. So, you can use a loan to meet your needs without impacting your financial growth.

Setting your own terms

When you borrow from a financial institution, such as an online lender or a traditional bank, they set the repayment terms. This includes minimum monthly payments, fees, and more. When you borrow from a cash value life insurance plan, you set your own repayment terms.

You can choose how much you want to repay per month or whatever payment term you prefer, or you can opt not to repay it at all. Remember, though, these loans still include interest and not repaying them means you must either pay annual interest or deduct the interest from the cash value.

Minimizing tax implications

If you invest in the stock market or put your cash in a savings account, you’ll likely see returns, but these returns are generally subject to income tax. With a whole life insurance policy that builds cash value, the cash value grows tax-deferred, much like some retirement accounts.

Tax-free growth isn’t the only tax benefit of family banking. The death benefit from your insurance policy typically goes to your beneficiaries tax-free.

Guaranteeing your investments

Yes, you can make a financial splash by hitting it big in the stock market or on real estate, but those investments also come with the risk of losing most or all of your investment.

With a family bank strategy, you don't have this risk as long as you continue making your premium payments.

Plus, since this is a life insurance policy, in most states, creditors cannot come after the death benefit or cash value if you have outstanding debts after death.

Teaching fiscal responsibility

Fiscal responsibility is something all kids should learn to help them properly manage personal finances in adulthood. Maybe it’s time for your teen to get a car, but they can’t get a loan yet. You can take out a cash value loan and write a repayment agreement with your child. They learn to pay you just like they would a traditional bank, but there’s no need for credit checks and other issues that come with securing a traditional auto loan.

What are the drawbacks of building your family bank?

Building a family bank isn’t all positive, as some drawbacks exist too. Let’s review these drawbacks so you can make a well-informed decision. 

Perceived inequality

If lending from the family bank is not administered properly, some family members may perceive it as inequitable. This can lead to some disharmony within the family over the finances. 

Potential wealth reduction

The family must set up firm repayment and forgiveness plans within the family bank. Without these rules in place, unpaid and unforgiven loans can reduce the family’s overall wealth over time. Also, by not repaying a life insurance loan, you reduce the death benefit by the unpaid amount.

High premiums

Whole life policies that build the cash value needed to create a family bank can be costly. The cost of coverage for a whole life policy is significantly higher than the premiums of a term policy with the same amount of coverage. 

Interest rates

Remember, even if you aren’t taking out a loan from a traditional financial institution, there are still interest rates. As mentioned earlier, the insurance company will still charge interest for the loan. 

Set your family up for financial wellness with Greenlight

Private family banking is one option for managing your money. A whole life insurance policy can be used to handle your final expenses and potentially accrue enough cash value to launch a private family banking strategy for borrowing money and building generational wealth. But be sure to do plenty of research and consider the pros and cons before embarking on this strategy.

Greenlight tip: You should contact a financial advisor or insurance agent to discuss your specific situation.

The Greenlight app can also aid in securing your kids’ financial futures by offering financial literacy lessons and allowing you to show them how to invest in the stock market. Sign up for Greenlight today and see how it can help.