What is an Immediate Financing Arrangement?
With the state of the world and the Canadian economy right now you’re probably going to hear more and more about this concept.
The immediate financing arrangement is an advanced strategy that should only be done by professionals who know what they are doing and should only be done for clients who are financially stable, with a high cash flow and high net worth.
In this blog we give a high-level overview of the Who, What, When, How, Why.
Who is the Immediate Financing Arrangement for?
This strategy is great for people who need a large amount of permanent insurance for estate purposes but don’t want to tie up large amounts of capital in a life insurance policy.
Often times incorporated business owners who have a holding company with significant retained earnings utilize this strategy.
Who is involved in the IFA process?
There are 2 main parties involved that work together but are completely separate entities.
First you work with an insurance company who offers a dividend paying participating whole life policy. This is the core element of the strategy and the main reason we use strategy.
The second party is the bank. The bank is actually who invented the name Immediate Financing Arrangement, it’s a bank term for this type of lending.
The bank is who you are going to bring the insurance policy to as collateral. If the bank underwriting accepts you, they will set up a credit facility against the cash surrender value of the life insurance policy.
You will also need to work with the business owner’s accountant and lawyer in order to set this up and get all the paperwork done correctly.
Who is Safe Pacific, and how we can help
As part of our service at Safe Pacific we coordinate information between the various parties and make sure everyone has what they need to move forward – you, the insurance company, the bank, your accountant, your lawyer.
If you need an introduction to an accountant or lawyer that understands insurance and how these strategies work, we have a network across Canada that we can introduce you to.
This is specialized information and not all lawyers and accountants specialize in life insurance, corporate structure and tax so it’s best to work with someone who knows what they are doing.
If your accountant or lawyer needs some support we can introduce them to subject matter experts to consult.
What does it take?
On the life insurance side you can set up whatever premium amount you want. But on the bank side, they won’t set up IFA lending unless you deposit a minimum amount into the policy each year.
The minimum depends on the bank, but the lowest minimum is an annual premium deposit of $100,000 and the average for banks is a minimum of $300,000 annual deposit.
Now, you have the insurance policy set up, you’re making your annual premium deposits, and you have the line of credit set up at the bank.
What do you do with it?
Well, you can do whatever you want with the money but you have to be careful – because you are using borrowed funds.
Obviously we don’t suggest you go out and buy Lamborghinis for all your friends, but technically you could do that if you want.
We highly recommend that clients use these funds to invest. That could be invest back in your business, invest in another business, invest in the market or real estate.
Some of our clients use this to grow their businesses, to buy inventory, or to float receivables in their operating company.
We also recommend you don’t invest this money in anything too crazy risky where you could lose it – because we are dealing with leverage here. You do owe the money, you still have to make annual premium deposits into the policy, and you need to service the debt with the bank with monthly interest payments that get bigger every year.
When Should you do this?
This is why we strongly suggest you use your immediate financing arrangement IFA during your working years. Things can change when you start to hit retirement years – say 50 or 55 and over.
After this age, we can set up a different financing arrangement with the bank – using the same policy asset that you’ve already funded for all these years. But that’s for another blog.
How does IFA work?
To begin with the business owner retains earnings inside their holding company – it can be inside the operating company, but it’s better to have some separation and have the funds in the holding company.
The you’re going to take the funds that are held in the holding company and use them to purchase a participating whole life insurance policy.
Now you are going to overfund the life insurance policy to the maximum amount allowed by the CRA.
You do this so you can get as much cash surrender value as possible. The cash surrender value is the asset you’re going to use as collateral to secure financing from the bank.
Once you have the insurance policy in place, you take that policy across the street to the bank and assign it to the bank as collateral security.
In return, the bank gives you, the business owner, a credit facility against the life insurance policy.
Some banks will set up demand loans and some banks will set this up as a revolving line of credit. We can work with you to figure out what’s best for your specific situation.
Now, each year your holding company is going to make a large premium deposit into the life insurance policy.
When we get a confirmation of the premium deposit from the insurance company, we give that to the bank and they extend your facility, so your loan or line of credit available grows every year, as a result these can get quite big.
Why Life Insurance?
Well, a business owner needs life insurance of course. Suitable clients for this strategy own their house, have a family and have a business so they have a large life insurance need now and an even bigger insurance need when they pass away.
The bonus is that by using this strategy you can get all of the life insurance you need and not tie up all your cash by leveraging it out right away.
The reason you can leverage it so easily is because it’s such a safe and secure asset to own.
What makes life insurance so valuable is the special legal and tax attributes given towards it in Canada.
Life insurance in Canada is considered tax exempt and the growth inside these types of policies is tax deferred.
The rules around insurance in Canada have their own legislation – the Insurance Act. It is older than both the Bank Act as well as the Income Tax Act and comes with many advantages if you know how to leverage them.
Canada is one of the only countries left where you can set up these types of permanent insurance policies.
That’s our quick rundown of an immediate financing arrangement IFA and how it works.
You should now have a better understanding of who this strategy is for, what it takes to maintain an IFA, when it is ideal to start, how it works, and why you should choose life insurance as a source of collateral.
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