Maximizing Cash Flow
Do you need life insurance protection but don't want to tie up your cash flow?
Business owners need cash on hand. They also need tax-effective ways to grow their retained earnings, and a method for inter-generational wealth transfer. An Immediate Financing Arrangement (IFA) can address all of these needs. You can have your cookie, and eat it too.
You buy whole life insurance* and in the same year take out a collateral loan on the policy. The limit on the amount of the loan (structured as a line of credit) can be:
90% of the Cash Surrender Value of the policy (generally no additional collateral needs to be assigned to the lender for this option)
100% of the Cash Surrender Value of the policy (generally no additional collateral needs to be assigned to the lender for this option)
100% of the premiums paid (additional collateral will likely be required by the lender)
The choice is yours. The main consideration is how much risk you're willing to take on. Leveraging less of the Cash Surrender Value (CSV) is less risky. Taking a loan for 100% of the premiums is the most risky.
Additional collateral is usually required if you take a loan for full premiums paid because the cash value inside the policy (which is the primary collateral) will be less than that amount, due to surrender charges and the cost of insurance.
*Note: Banks typically require whole life instead of universal life because the structure is less volatile due to the smoothed funds that investments are put into for whole life policies.
Who is this strategy designed for?
An IFA is ideal when:
You have a need for life insurance
Your personal corporation has enough retained earnings to deposit a large amount into the policy ($30k or more, allows for more potential growth of the CSV)
The loan would be used to generate business or investment income
You are comfortable with leveraging
How does it benefit me?
There are several reasons an IFA is a valuable tool:
If the collateral loan is used to generate business or investment income, the interest is tax deductible.
The Cash Surrender Value (CSV) grows each year, which can increase the loan cap and how much interest you can deduct, provided the loan is used in a way that allows for deductions.
If the collateral loan is used to generate business or investment income, part of the cost of insurance can be tax deductible.
You are able to get vital insurance coverage without significant impact to your cash flow. The money you put in can immediately be replaced by leveraging the policy.
The growth inside the policy is non-taxable. If you decide you don't want to immediately leverage your policy, you still get the tax advantages of investing inside life insurance. Later on, you have the option of putting a Corporate Insured Retirement Strategy into place using the internal savings.
If you use the IFA approach, you can still start a CIRP by paying off the loan for the IFA first.
How do I get one?
The first step is establishing an insurance need. Good examples are: funding a buy/sell agreement, covering estate taxes, maintaining your family's lifestyle after you're gone, or paying off outstanding loan obligations on death.
Next you apply for insurance with the guidance of your Taxevity team. Approval is not guaranteed, but we always contact underwriters ahead of time to prepare you for what the outcome may be.
Once you're approved and make your first planned deposit, we apply for an IFA with a financial institution experienced with life insurance leveraging such as Manulife Bank or BMO Bank. This process requires financial statements from your personal corporation and you, as well as a brief biography and loan and mortgage statements.
After approval, you will have a line of credit with a maximum based on the structure your selected, which you can use as you like. You pay the interest on the loan annually - unlike a Corporate Insured Retirement Plan, the interest cannot be capitalized under an IFA (added to the loan balance). If you use the loan to generate business or investment income, you can claim an interest deduction the following year. The bank may require you to assign additional collateral for the initial years.
There is an annual review by the bank where they request an inforce illustration (which we can handle for you) and potentially other documents provided during application. They also charge a small fee - usually a few hundred dollars.
What are some of the risks?
The nature of a collateral loan and thus an IFA means it can be affected by:
Your credit worthiness and that of your business
The bank reviews these arrangement annually to ensure they are still viable
The bank's policies regarding IFAs or loans in general changing
The loan rate changing
You may need to assign additional collateral if the rate changes dramatically
Your income changing (including risk of sudden illness or disability)
The banks require proof of sufficient income to justify the loan on an annual basis
Capping the loan can mitigate this risk
Tax rules regarding IFAs changing
Rate of return inside the policy being lower than anticipated
Your desired outcome may not be reached for a specific year
Using whole life reduces the likelihood of sudden changes in rate of return