Immediate Financing Arrangements (IFAs) offer a strategic advantage for business owners and managers who manage health and group benefits for their organizations. This sophisticated financial strategy leverages the cash surrender value of permanent life insurance policies, enabling access to cash while maintaining valuable insurance coverage.
Understanding Immediate Financing Arrangements
An Immediate Financing Arrangement allows policyholders of Universal and participating life insurance policies to obtain the permanent life insurance coverage they need while preserving cash for investment opportunities. This strategy uses the cash surrender value of a participating life insurance policy as collateral for a loan or line of credit from a third-party lending institution.
As the policy’s cash surrender value increases, loans are taken out against it. The proceeds from these loans can be reinvested into the business or other income-producing assets, with potential tax-deductible interest expenses. Upon the insured’s death, the outstanding loan balance is repaid from the policy’s death benefit, with the remaining proceeds paid to the corporation.
How Immediate Financing Arrangements Work
1. Purchase of Policy: The corporation purchases a permanent participating life insurance policy on the business owner’s life, creating significant cash surrender value in the early years.
2. Policy as Collateral: The policy is assigned to a lending institution as collateral for a line of credit.
3. Payment of Premiums and Interest: The corporation pays the recurring policy premiums and the interest on the loan.
4. Borrowing Against Value: The corporation may borrow up to 100% of the policy’s cash surrender value or an amount equal to the annual policy premium with additional collateral security.
5. Investment of Loan Proceeds: The borrowed funds are used for investment purposes, such as funding the business, purchasing real estate, or investing in other income-producing assets.
6. Annual Repetition: These steps are repeated annually.
7. Repayment Upon Death: Upon the insured’s death, the outstanding loan is repaid from the policy death benefit, with the remaining proceeds paid to the corporation.
Benefits of Immediate Financing Arrangements
- Tax Efficiency: Business owners can shelter growth on corporate invested assets from tax within the life insurance policy. This strategy allows for the re-investment of retained earnings sitting within a participating life insurance policy into the business or other income-producing investments.
- Interest Deductibility: When a corporate loan is used to earn income from a business or other investment, the interest on the tax-free loan may be tax-deductible. A portion of the life insurance policy’s premiums may also be deductible.
- Liquidity and Coverage: This strategy provides liquidity for corporate life insurance needs, such as coverage for a key person, funding buy-sell agreements, or paying dividends to shareholders. Death benefit proceeds can also be used for tax liabilities, estate equalization, or leaving a legacy to heirs or charities.
- Capital Dividend Account Credits: The death benefit in excess of the policy’s adjusted cost basis creates a credit to the corporation’s Capital Dividend Account, allowing tax-free dividend payments to shareholders.
Risks to Consider
Low borrowing rates may make IFAs appear favourable, but they are long-term arrangements reviewed annually by the lender. Advisors and clients must consider scenarios where the policy’s cash surrender value decreases while the interest rate increases, potentially requiring additional collateral, partial loan repayment, or policy surrender, which can have tax implications.
Suitability for IFAs
IFAs are best suited for healthy, financially stable clients aged 35 to 65, including individuals and business owners with significant annual surpluses or large retained earnings in taxable investments. These clients should have a high tolerance for risk, a long investment horizon, and a substantial need for permanent life insurance. The strategy requires the involvement of professionals such as accountants, lawyers, tax specialists, and financial advisors.
Common Questions About Immediate Financing Arrangements
1. What is an IFA, and how does it work?
An IFA allows clients to borrow up to the amount of the insurance premium paid, using the policy’s cash surrender value as collateral for a loan from a third-party lender.
2. How much money can be borrowed back?
Generally, IFAs allow borrowing up to 100% of the premiums paid, though the actual amount depends on the lender and borrower’s circumstances.
3. Does the lender take ownership of the insurance policy?
No, the lender does not become the policy owner. The actual policyholder remains the owner, with the lender having rights as collateral security.
4. When does the loan become due?
The outstanding balance is typically due upon the insured’s death, though lenders can demand repayment anytime. In case of default, the policy’s cash surrender value may be used to recover what is owed.
5. What will beneficiaries receive when the policy is redeemed?
After repaying the loan from the death benefit, the remainder goes to the beneficiaries, ensuring there is always residual money to pass on.
6. Are IFAs only beneficial to ultra-high-net-worth clients?
IFAs are complex and best suited for clients with an annual premium of $100,000 or more.
7. What other collateral is required for an IFA?
Many lenders require additional collateral, but some only require the policy.
By understanding and leveraging Immediate Financing Arrangements, business owners and managers can enhance their financial flexibility, maximize the value of their permanent life insurance policies, and support the growth of their businesses. Contact us for more information.
