What is an Immediate Financing Arrangement?

Immediate financing arrangements (IFA) are a financial planning tool that allows incorporated business owners and individuals to buy participating permanent life insurance without reducing cash for business or investment opportunities.

With IFAs, the cash surrender value of a life insurance plan is used as collateral for getting a loan or a line of credit from a life insurer or a Canadian bank. This means the IFA can help you get more credit. As the cash value of your life insurance policy increases, the amount of money you can borrow also goes up. Borrowing against your policy may be very helpful in many ways.

During the premium payment period, you can usually borrow back up to 80-90% of the cash surrender value. In some cases, the lender may let you borrow up to 100% of the cash surrender value. 

You may spend the loan proceeds however you see fit. You can use it to help your business, for example, to boost cash flow, fund income-producing investment vehicles, or successfully complete an acquisition.

For tax deductions, you may be able to deduct interest expense from total income to reduce your taxable income. Also, part or all of the insurance premiums may be tax deductible when a life insurance policy is used as collateral for a loan.

When you pass away, the policy proceeds pay off the entire loan that the borrower took. If the insured is a corporation, the corporation will be the policy owner and the beneficiary. The corporation can distribute the residual death benefit tax-free to your estate. Alternatively, it can use the payout to increase the cash flow or distribute it between the surviving shareholders. 

How Does an IFA Work? 

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A typical Immediate Financing Arrangement works in the following way: 

1. A corporation takes out a participating permanent life insurance plan on an owner or key employee. Permanent life insurance policies that accumulate substantial cash value in the initial years are usually preferred. 
2. The corporation is both the owner and the beneficiary. 
3. The cash surrender value of the policy is used as collateral by the corporation to obtain a line of credit from a life insurance company or a Canadian bank.
4. As the policy owner, the corporation pays the insurance premiums and the interest payments on the collateral loan. 
5. The corporation uses the loan proceeds, (up to 80-100% of the cash surrender value), to generate income. It may use it for expanding the business, investing in income-generating vehicles, or buying real estate.
6. Upon the insured’s death, the corporation receives the funds tax-free, and uses part of the funds to pay off the loan.

Benefits of an IFA

The main benefits of an Immediate Financing Arrangement are: 

1. Allows business owners to preserve cash

The main benefit of an immediate financing arrangement is that it allows you to get the life insurance coverage you need without taking out cash from your business. Instead, you could decide to set up an immediate financing arrangement to borrow back 90% of your cash surrender value and use these funds for business or investment portfolio that will generate profits. As a result of this arrangement, the policy costs you only a fraction of its true premium cost. 

Lastly, you may also be eligible for collateral insurance deduction. Generally, insurance premiums are not tax deductible for income tax purposes. However, with collateral insurance deduction you may be able to claim a deduction if you collaterally assign the policy to secure a loan and use the latter to earn income from business or investment.  

2. May claim interest expenses as tax deductions

The interest on a corporate loan used for generating income may be counted as part of your tax deductions. So, if you name your company as the policy owner on your life insurance policy and take out a business loan, you may be able to deduct the interest expenses in tax write-offs.

In addition to claiming the interest expenses as tax deductions, you may also be able to avoid paying tax on a part or all of the policy premiums.

3. Meet corporate life insurance needs

Because an immediate financing arrangement reduces a company’s net cost of buying a life insurance policy, it becomes easier to take out a policy on a key employee or fund a buy-sell agreement. 

However, IFAs are not suitable for everybody. Consider an IFA if you: 

• own an incorporated business and want life insurance coverage to protect your family’s future
• want a permanent life insurance policy but do not want to take money out of your business to pay the recurring insurance premiums
• are eligible for a medically-underwritten life insurance policy 
• are a high-net-worth individual
• want to use life insurance to fund a buy sell agreement or buy key person insurance without reducing the cash available for your business .

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How to Structure an IFA

An immediate financing arrangement can be set up in three ways: 

1. If you already have life insurance, you can use it for an immediate financing arrangement, provided your policy has cash value. Only permanent life insurance plans can be used for IFAs. Generally, you can borrow up to 80-90% of your policy’s cash value, though some financial institution may be willing to lend you 100%. Term life insurance, which does not accumulate wealth, is not suitable for this financial strategy. 
2. If you do not have a permanent life insurance policy or only have a term life plan in your name, you can take one out. Once your policy has built up a sizable cash value, you can use it as loan collateral on some financial institution. Different full life plans build cash value differently. If you are interested in an immediate financing arrangement, consider a plan that accumulates cash value quickly during the first few years. 
3. If your policy does not have enough cash value, you can borrow an amount equaling 100% of the annual premium that has been paid. However, you will likely be required to use additional assets, like real estate or investments, as collateral. 

Repaying the IFA Loan

Generally, the balance on the debt is paid after the insured's death. The insurer pays the outstanding loan directly to the lender from the policy proceeds, while the remaining death benefit is issued to the beneficiary. If desire, you can also pay off the entire loan while you are still alive. 

Risks of an IFA

Immediate financing arrangement loans are a long-term arrangement and as such the biggest risk to consider is a change in the interest rate. The lender can change your interest rate based on the markets and/or any changes in your financial position.

A rate change can increase the interest expense and policy performance over the term of your immediate financing arrangement. If the rate increase leads to a situation in which your loan balance exceeds the negotiated ratio of the surrender cash value, you may be asked to repay a part of the owed amount or provide additional collateral security.

Who will be responsible for the interest payments?

The responsibility for the interest payment will depend on the type of loan and the agreement between the lender and the borrower. Generally, the borrower is responsible for making interest payments on any loan that they have taken out. This includes mortgages, student loans, auto loans, and personal loans. For mortgages, the borrower is typically responsible for making monthly payments to the lender that include both principal and interest.

Conclusion

An immediate financing arrangement is an option for all those who need life insurance coverage but hate the idea of paying monthly premiums with money they can use to generate income. This financial strategy allows you to enjoy the benefits of life insurance without reducing cash available for business or investment purposes.

Keep in mind that you will have to pass medical and financial underwriting and only permanent life insurance plans can be used for structuring an immediate financing arrangement. 

If you are interested in setting up an immediate financing arrangement, Dundas Life can save you money by ensuring you get the right coverage at the lowest price. Schedule a call with us today.