Immediate Financing Arrangement (IFA)

In business ready access to cash ensures security and it enables the business to grab hold of opportunities that can lead to growth. Having a positive cash flow encourage a business and its shareholders to actively seek out openings that will promote the potential expansion of the business. Taking funds out of circulation to buy life insurance is perceived as a threat to the business and even though life insurance is an important commodity, business owners are often reluctant to make the purchase. There is however a way in which one is able to purchase a life insurance policy at a premium that will allow you to make use of the policy itself as collateral when applying for a loan. It is called Immediate Financing Arrangement or the IFA for short.

What is the Immediate Financing Arrangement?

An IFA is the practice whereby you take out a premium life insurance policy that has a cash building component, such as an exempt whole or universal life insurance policy and then directly use the policy as collateral to obtain a loan. In this way you gain the full benefit from the insurance policy, yet you are still able to use your money to build your business or to invest into other income generating avenues.

How the IFA works to help you get more tax deductions.

Your accountant will be quick to point out that a business can take out a life insurance policy on any of its members. Such a life insurance policy would then get paid with corporate funds that is taxed at a lower rate than personal income. Over the lifespan of an insurance policy this can amount to a significant amount of money. These tax savings becomes even more pronounced when the insurance policy has a cash building component attached to it.

Having now bought and paid for the insurance policy with money from the business, one can immediately use the policy with its cash surrender value (CSV) as collateral at a bank or financial institution to take out a loan. This then frees up your cash flow again and you can put the funds back into growing your business. Alternatively you can use the money for investment purposes in order to accumulate more income.

The three steps to setting up an IFA strategy are:

Your business takes out a life insurance policy in the name of one of its members.
The policy is offered up as collateral in order to obtain a loan from a bank.
The loan is used to boost the growth of the business or as investment.

Structuring an IFA

The first point to that needs to be made is that only insurance policies that has a cash surrender value (CSV) component can be used when one is planning to create an Immediate Financing Arrangement. That basically implies that you take out either a Whole Life Insurance Plan or a Universal Life Insurance Plan. Any of the Term Insurance Policies won’t work as they don’t have CSV capabilities. Insurance companies usually require medical certification as well as financial statements and documentation. It is also important to consider that the policy should be so structured as to offer the highest possible cash surrender value. This is achieved by the investor paying premiums that exceed the cost of the insurance. In doing so, interest and a percentage of the premium can be deducted against income, giving the investor clear tax benefits.

The actual structure of an IFA can take one of three basic forms:

The first format is that the loan is based on the cash value of the insurance policy. Commonly financial institutions and banks will approve a loan of between 75% - 90% of the cash value and you might even be able to get a 100% loan from some lenders.
A business might have opted to pay a higher premium than the value of the cash value of the policy. To rectify this cash outlay imbalance the entire premium needs to be lend to the business. To facilitate this the bank would require additional collateral. This can be in the form of real estate, investments or other assets.
The third format relies on the bank advancing the premium and yearly net interest, allowing for a limitless internal rate of return.

The finer points of structuring an IFA are influenced by various factors, not least of which depends on how banks and financial institutions all have different criteria that determine how they lend money.

What other benefits does an IFA hold for a business owner?

Paying for the life insurance policy through the business, using lower-taxed corporate funds is not the only tax benefit that can be derived through setting up an IFA.

What other benefits does an IFA hold for a business owner?

Interest charges on the loan: When the capital from the loan is invested back in to the business or into another income generating venture, the interest charges on the loan can be tax deducted.
Collateral insurance: When the policy holder and the borrower is the same person, a second tax reduction applies. Collateral insurance deduction relates to the policy itself. It is the sum of the lesser of premiums and the net cost of pure insurance (NCPI). This indicates the true mortality cost of the policy.

Early on in the life of the policy, the NCPT value is relatively low, but as an IFA is a long term strategy, this does become a significant part of the policy.

The risks involved with an Immediate Financing Arrangement

Investment strategies all come with some degree of risk and it is important that these risks are properly understood and disclosed. It is the only way that you can determine whether or not a particular strategy is suited to your scenario.

Rate changes:

I have mentioned before, an IFA is generally a long term strategy. This means that during its time, rate changes will most likely occur.

As the interest rates adapt to the greater economy, it will have an effect on your strategy. It is therefore advisable that before you structure an IFA, you get hold of insurance illustrations that depict a variety of interest or dividend rates.

It is important that you avail yourself of what will happen should the interest rate that effect the cash surrender value (CSV) of your policy decrease at the same time as the floating interest rate increase.

You will be faced a capital deficiency and will be required to:

1. Offer up additional collateral

2. Pay back a part of your credit line

3. Surrender the policy.

Surrendering the policy will have far reaching consequences. Any excess amount over the adjusted cost base or ACB would be subjected to capital gains tax.

It is not advisable to consider an IFA if you do not have the assets at your disposal to cover the annual premium without borrowing or to be able to repay the loan should it become necessary.

Tax deductions:

As tax deductions are of special interest to incomes that are subjected to high taxation, one should consider how this will impact on the business when the policy holder is in his or her retirement years.

Personal loans:

Potential exist for an individual to use the corporate policy as collateral for a personal loan. This may then result in the loan being classified as a shareholder benefit and will fall in the highest tax level. In order to avoid this, a guarantee fee is payable to the corporation. The fee is generally calculated as between 1% - 3 of the personal loan.

Death:

Provisions should be in place that at the time of death, when the policy pays out to the beneficiary that payment should be channeled through will and estate planning documents. These documents should specify the sequence of transactions between the business, lender and member’s estate in order to avoid being classified as a shareholder benefit. This needs to be done to avoid being taxed at the highest rate.

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info@hexavision.ca

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License #s: FSCO LIC#17161321 (ON), AIC LIC # M-3493167-1763384-2020 (AL), BC LIC#LIC-2020-0022136-R01 (BC). Insurance and segregated funds providdes by Carte Risk Management Inc.

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Contact

(647) 556-5605

info@hexavision.ca

1 - 45 Lewis Rd Guelph, ON N1H 1E9

Our Service Area

Ontario Quebec

Alberta New Brunswick

British Columbia Saskatchewan

Working Hours

🟢 Monday to Friday : 9:30 - 6:30 EST

🔴 Saturday and Sunday : Closed

social media