Immediate Financing Arrangements  

Taxes are the biggest expense Canadians face, and we often help clients plan for their future tax bill.
I’ve recently had several clients ask about Immediate Financing Arrangements (IFAs) -they’ve heard the term thrown around but are not sure what they are and how they can help. Immediate Financing Arrangements can be a solution to help cover future tax bills, or fund other liquidity needs without disrupting cash flow needed to continue growing your business. Here’s how they work:

Your business (typically your Holding Company) purchases a Permanent Life insurance policy on your life, which will be used to fund your future tax bill.

Since you don’t want to disrupt cash flow, your business applies for and obtains a bank loan to replace the money used to pay the insurance premiums. The insurance policy is now assigned to the bank as collateral for the loan. Financial institutions recognize the stability of permanent life insurance and, depending on the lender, accept between 90 and 100 per cent of a participating policy’s cash value as collateral for a loan. Your business pays interest on the loan over time, and it can be paid off at any time.

Here’s the sweet spot – your business may obtain two tax deductions, as a result using the loan for business or investment purposes. The first is the interest deduction, as interest is tax deductible if it’s paid on a loan that’s used for business purposes.

The second is the collateral life insurance deduction.

Generally, the owner of a Life insurance policy can deduct the lesser of the policy’s net cost of pure insurance and the premium payable when the policy is assigned to the bank as collateral for a business or investment loan.

(Deduction=NPCI-Premium) when the policy is assigned to the bank as collateral for a business or investment loan.

On your death, part of the insurance proceeds pays off the bank loan, and part can be used to pay taxes and satisfy liquidity needs. Death benefits from Life insurance policies are credited to a Corporation’s Capital Dividend Account (CDA) and can be paid out as a tax-free capital dividend.

A significant advantage of the IFA is its low impact on the net cash flow in the first several years and the overall lower impact in the later durations.

Net cash flow is the annual interest payments minus the annual tax savings from the interest and collateral life insurance deductions.

Pete’s IFA Opportunity
We worked with Pete who owns a successful commercial construction business. He’s 60 years old, married, and has expressed the need to fund his future tax bill, which is estimated to be $7M. He decided that he would like to use life insurance as a solution to fund this tax bill. Pete has enough cash flow to fund the insurance costs, but his company is in the middle of a large project, and he would like to minimize other financial commitments until it’s completed.

Pete’s Holding Company will be the owner, payor and beneficiary of the insurance policy, and policy has a total annual premium of $250,000 payable for 10 years. Pete pledges the policy as collateral for a loan and uses the loan to pay the insurance premiums. The loan has an interest rate of five per cent, and after ten years the total loan will be approximately $2,500,000.

If Pete uses the IFA strategy, his net cash flow savings for the first 10 years is approximately $2,040,800. His net cash flow savings over 30 years would be approximately $540,621. He is now free to continue reinvesting his free cash flow into his business where it will be most productive. When Pete dies, part of the insurance proceeds pay off his bank loan, and the remaining pay the tax bill. This ensures that Pete’s family does not have to sell investments and real estate to pay any taxes, thus preserving their wealth.

In summary, the Immediate Financing Arrangement helps keep business and investment capital intact. The money used to pay the life insurance premiums are replaced by money borrowed from a bank. As a result, your business’s opportunity cost of obtaining permanent life insurance coverage is minimized.

IFAs also help keep costs of obtaining permanent life insurance coverage minimized in the short-term and may be significantly minimized over the remaining years of your life.

The Immediate Financing Arrangement is a transaction that should only be implemented in consultation with experienced lawyers and tax professionals. When we build financial plans for clients, we often work together with your trusted lawyers and accountants to ensure the right strategy gets put in place.

Please reach out if you think this could be of help to you.

Brent Vandekerckhove
Financial Advisor & Portfolio Manager
T 604 732 6551