How risky is an immediate financing arrangement?

An immediate financing arrangement or IFA can come with some risks, just like any financial strategy. But, risks are moderate and can be mitigated by working with a licensed professional.

Can I use an IFA for premium financing?

No, in Canada, you cannot use an immediate financing arrangement or any type of credit facility just to buy life insurance. But there is a fine line - you can technically use the funds you receive from an IFA for any purpose, so you can think of it as getting your premiums back, in a sense.

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What are the biggest immediate financing arrangement risks?

SUMMARY

An immediate financing arrangement is an advanced strategy that can help business owners, investors, and other high-net-worth individuals put their whole life insurance policy to the best use. But, it’s not for everyone. Without the support of experienced professionals, there are substantial risks that may impact your desired financial outcomes. You could end up leaving less funds behind for loved ones, paying more interest than you intended, and more.

By Jiten Puri

CEO & Founder, Insurance Advisor, LLQP

11 min read

June 17th, 2024

IN THIS ARTICLE

What are the risks of an immediate financing arrangement?
What is an immediate financing arrangement (IFA)?
Why do people get IFAs?
Is it risky to get an IFA?
How to avoid IFA risks
Speak with a professional

An immediate financing arrangement or IFA can be a convenient strategy for people with high incomes, but there are risks involved. Keep reading to find out what those risks are and how you can best avoid them.

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What are the risks of an immediate financing arrangement?

Some of the biggest risks of using your life insurance policy for an immediate financing arrangement are:

Dividend scale fluctuations
Changing loan interest rates
Changing terms
Lower death benefit
Unexpected changes in your financial situation
Loss of collateral or assets
Fees
Possible credit impact
Possible tax implications

Dividend scale fluctuations in the life insurance policy

Fluctuations in the dividends of a life insurance policy pose risks for an IFA by impacting the policy’s cash value growth. If dividends decrease or fail to meet the current projected dividend scale, the cash value may not accumulate as projected, potentially leading to insufficient funds for future collateral loan drawdowns.

If the dividend scale decreases, the policyholder may also need to fund more premiums out-of-pocket to keep the policy in force and maintain the desired death benefit level. This can strain financial resources and disrupt long-term planning, requiring policyholders to adjust their access to cash flow from the IFA and potentially delay debt repayment strategies.

Relying heavily on dividends in a policy favoring the ADO means the accumulation of funds is dependent on their payout, yet since dividends aren’t assured, there’s a risk that the coverage might fall short of projected illustrations, resulting in less coverage than expected.

Fluctuating dividends in a whole life insurance policy pose risks for IFAs by impacting the policy’s actual cash value growth as compared to illustrations. If dividends decrease or fail to meet the current projected dividend scale, the cash value may not accumulate as projected, potentially leading to insufficient funds for future collateral loan drawdowns. The risk is more elevated in structures where the ADO component is high as chosen by you in the current policy. The policy heavily relies on future dividend scales to meet its growth expectations and its ability to absorb the assumed additional deposit options, while staying within prescribed limits.

Decreases or failing to meet projected scales may lead to insufficient funds for collateral loan drawdowns, requiring additional premium payments and potentially disrupting long-term planning, leading to adjustments in cash flow access and delaying debt repayment strategies.

Growth fluctuations

Most IFAs come with the expectation that your business growth will pay for the interest charges you’re responsible for. But one of the biggest risks is if you end up having a lower rate of return than expected. If returns aren’t sufficient to cover your interest, you could have out-of-pocket costs for those fees — and that’s financial capital you could have put to better use.

Changing loan interest rates

If interest rates or floating loan rates increase, the bank will pass that on to you. Just like with growth fluctuations, increasing interest could also leave you paying out more than you’re bringing in. This can have a fairly significant impact if the interest is being capitalized. Depending on your arrangement, your lender could potentially also ask you to provide additional collateral to make up for higher interest build-up than the projections.

Change in lender terms

An IFA is offered through a financial institution like a bank or third-party lender, and they can change the terms of the agreement in the future at their discretion.

Lower death benefit

Most IFAs are made to be paid out of your death benefit when you pass. But you should keep an eye on this. Remember, the entire point of life insurance is to give your surviving family a lump sum they can use to offset estate taxes or for anything else. Be careful that the amount deducted from your death benefit proceeds doesn’t leave your family without enough funds for their purposes.

Unexpected changes in your financial situation

A sudden sickness, injury, disability or other unexpected event could impact your ability to earn income and keep up with IFA interest payments or other loan obligations. Some lenders ask for proof of sufficient income to justify the credit every year, and a sudden drop in your income could impact that.

Loss of collateral or assets

Sometimes, a bank or external lender may ask for additional collateral for your IFA agreement with them. If you’re unable to pay in the long run, they could acquire those assets entirely.

Fees

Depending on which bank or third-party lender you choose, there may be fees associated with an IFA. You should ask about these upfront and read the agreement’s details to make sure you’re aware of any possible charges, late fees, admin fees, etc.

Possible credit impact

When you apply for an IFA, it can appear on your credit report. This may impact your credit score or the creditworthiness of your business, or have other far-reaching implications.

Possible tax liabilities

You may be responsible for paying taxes on the amount borrowed through an IFA unless you plan on using it to reinvest. Most people who start an immediate financing arrangement reinvest the funds to maximize their returns, but you should still be aware of this risk when deciding whether you want to start an IFA.

Availability of tax deductions

The ability to utilize tax deductions with an IFA loan depends on using the loan for business or investment purposes and using the policy as collateral. This may lead to tax savings from deductions on interest and collateral insurance.

However, to benefit from these deductions, the borrower must meet specific tax rules and have enough income to utilize them. If income is insufficient, the actual costs may be higher than anticipated, especially as the loan balance grows over time. It’s crucial to carefully monitor and address any issues with utilizing deductions to ensure the expected benefits of the IFA strategy are achieved.

Change in tax laws and CRA interpretations

Tax regulations undergo frequent changes, leading to variations in how loans, interest deductions, and life insurance policies are treated over time. With the General Anti-Avoidance Rules (GAAR) in place, the Canada Revenue Agency (CRA) has the authority to classify a collateral loan as a policy loan, resulting in distinct tax consequences.

Each loan possesses its own distinctive attributes, making it essential for the policyholder to thoroughly assess the reasons behind obtaining a collateral loan. Moreover, given the intricate and ever-evolving nature of the tax landscape, consulting with a tax advisor is strongly recommended before proceeding with the transaction.

What is an IFA?

An immediate financing arrangement is a unique insurance strategy where you use a whole life insurance policy as collateral to open a line of credit with a financial institution, such as a bank or lender.

You can instantly access up to 100% of the premiums you paid for the insurance policy, or up to 100% of the cash value. Unlike a regular bank loan or collateral loan, an IFA is literally immediate — you could buy cash value life insurance today and apply for an IFA right now.

Why do people get insurance financing arrangements?

High-income earners in Canada use IFAs as a convenient way to get the benefits of life insurance coverage while also getting liquid assets right away.

It’s especially useful for business owners, private corporations, and other high-net-worth individuals. With an IFA, they can access immediate access to capital without tapping into current income.

Common uses for an IFA

Most people use the proceeds from an IFA for:

Recouping insurance premium payments
Estate planning or estate equalization
Instant cash flow (and the flexibility that affords)
Business continuity planning
Real estate purchases
Investment opportunities
Small business capital
Funding a buy-sell agreement
Other business purposes
And more

In a way, an IFA lets you recoup the amount you paid in premiums, so you can use those funds for revenue-building ventures. You can then use those returns for interest payments on the agreement. An IFA can almost be thought of as paying for itself in that sense.

Is getting an IFA risky in general?

Yes, an IFA can be a risky and complex financial strategy for the reasons we highlighted in this article. But this is not uncommon. Many financial and insurance strategies come with varying degrees of financial risk.

The more important question is what your risk appetite is like, and where an IFA fits on that scale. This is why we always recommend that you speak with a professional before deciding to start an IFA. An experienced advisor can help you ensure your IFA works as planned and gives you maximum benefits.

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How to avoid immediate financing arrangement risks?

We, as insurance professionals, understand the risks involved with immediate financing arrangements in Canada, even though they can’t be entirely avoided. Having said that, you can certainly mitigate the risks of getting immediate financing. Here are some tips on how to avoid IFA risks:

1 Research and think carefully

An IFA is a great financial strategy that works best when you spend some time mapping out how you want it to work. Start by thinking about the risks that may be involved and if the benefits of an IFA are worth it, based on your circumstances.

2 Work with professionals

For a complex strategy like an IFA, we strongly recommend that you speak with an experienced, licensed professional who can provide expert insurance insights.

Even if you haven’t made up your mind yet but you’re just thinking about your options, you might want to speak with both your insurance provider and your accountant. They can help you avoid as many risks as possible and make the most informed decision to achieve your goals.

3 Be open to alternative arrangements

IFAs offer attractive benefits, but they’re not for everyone. If an IFA isn’t the best strategy for you, that’s ok. A licensed advisor can still give you guidance about other products that best fit your needs. There may be other strategies or products you don’t even know about but that are just what you’re looking for.

4 Understand the fine print

One of the best things about immediate financing arrangements in Canada is the flexibility in terms — no two agreements are the same. But, you should pay close attention to all of the terms and conditions laid out in your agreement with your lender.

Agreements can vary between lenders and even individuals, so you should make sure you fully understand exactly what you’re getting into before you commit. This is another area where you can rely on expert advice to make sure you clearly understand the details of your loan arrangement.

5 Borrow responsibly

With IFAs, your maximum loan amount is up to 100% of your annual life insurance premiums or the estimated cash surrender value amount stated in your life insurance illustration. This is a significant capacity that can be beneficial for high-net-worth individuals who need a large amount of insurance coverage.

But, remember to find balance. The outstanding loan balance will be deducted from your life insurance proceeds, so it’s best to avoid getting an IFA for an amount so large that it cuts too much into the funds you intend to leave behind for your beneficiaries.

Speak with a professional

If you’re thinking about starting an immediate financing arrangement, speak with one of our licensed insurance advisors.

As Canada’s best online insurance broker, we work with more than 30 of Canada’s best life insurance companies. We can help give you tailored guidance about what kind of permanent life insurance policy to use for an IFA or whether that may be the right strategy for your needs.

Need help?

Call us at 1-888-601-9980 or book time with our licensed experts.