Immediate Financing Arrangements (IFA) Strategy Case Study

Can you afford to let it slip through your fingers?

You, as a successful business owner, expect a great deal from your financial advisors. You expect them to have excellent knowledge to support you every step of the way. As Financial Advisors, we are determined to bring you the best strategies and services. We want to bring you the protection you need to grow your business. Today, I want to introduce an advanced financial planning strategy – Immediate Financing Arrangements (IFA) to you. If used properly, it can help many business owners achieve their dreams much faster.

Before talking about this strategy, let’s discuss some challenges that entrepreneurs often face:

1. Key person protection
2. Business loan protection
3. Buy-Sell agreement financing
4. Executive compensation

1. Key person protection

For many small companies, the fate of the firm is often in the hands of a few key persons. If something happens to them, the company may need to spend a lot of time and money to replace them. In reality, not many companies would have the resources to deal with an unexpected event. They would rather put all the money in business operation instead of a savings account. To protect the company from unexpected life events, they could purchase life insurance for all of its key persons. If something happens to them, the insurance proceeds can help the company survive during difficult times.

2. Business loan protection

By the same token, when small businesses apply for a loan, banks often require them to buy life insurance to cover their key persons because if they die in an accident, the company’s operation may be greatly impacted. Banks do not want to take risks on their loans. In the event of an accident, they want to make sure that the business can still repay the loan.

3. Buy-sell agreement financing

Many business owners know the importance of a buy-sell agreement. It is an agreement among owners that governs the situation if one of them dies or is forced to leave the business. For example, if one of the founders dies, the other founders will have the priority to purchase his shares. They don’t want outsiders to control their company. It is a good idea to have a buy-sell agreement in place. But many of them forgot to plan how to finance the agreement. If a member dies, do they have the resources to purchase his shares immediately? If not, they may need to buy life insurance for all parties in the agreement to mitigate the funding risk.

4. Executive compensation

The competition for talent is very intense. To attract and retain talent, a company needs to offer them a competitive compensation package. Life insurance can be used as a work benefit to attract talent.

In order to tackle these challenges, small business owners know they need to have life insurance for their business. But many of them don’t have it. Why? You guessed it: “I don’t have the money.” It’s true that resources are often extremely limited. Business owners want to invest all of their money in business operations. When risks come, they will find a way to deal with them. Putting money in a savings account is not the best way to use limited resources. It sounds very reasonable but when the risk comes, they often find out that there are not options for them to choose from. It is hard to make decisions, especially under extreme time constraints. That’s why it is important to have a risk management plan in place before the unexpected thing happens. As Buffett said: “It’s only when the tide goes out that you learn who has been swimming naked.”

As your financial advisor, we certainly can’t allow this to happen. In our toolbox, we can use an immediate financing strategy to help you solve this dilemma. We can help you to get a bank loan to pay for the insurance premium. You only need to pay interest each year to keep your policy active. Consequently, the purchase of insurance will not take up the company’s valuable resources.

How does this strategy work?

Step 1: You submit an insurance application to the insurance company and a loan application to the bank simultaneously.

Step 2: After the insurance application is approved, you will pay the insurance premium to the insurance company first, then assign the policy to a bank as collateral.

Step 3: After your loan application is approved, the bank returns the premium back to the company. Then you can use the money whatever you want without any restrictions.

Step 4: When the insured dies, the death benefit will repay the outstanding loan balance. Any excess amount will be paid to the company.

(Source: Manulife)

Through this strategy, you can get a tax-exempt insurance life policy by just paying the interest. Moreover, the interest paid may be considered as interest expenses; therefore, it is fully deductible from your taxable income.

Generally, the insurance investment returns are more than the loan interest. You are essentially double-dipping. On the one hand, you provide the much-needed protection for your company; on the other hand, the insurance will not tie-up the operating resources. You can still fully invest in your company. It’s the best of both worlds. Nevertheless, the investment income of insurance is not considered to be passive income and does not affect the small business deduction.

Case study:

Mr. Johnson is the founder and CEO of his company. He is crucial to the company’s success. If something happens to him, his company needs to find a successor quickly to replace him. He urgently needs life insurance to protect his company, but he does not have extra money to fund the policy. Based on the situation, his financial advisor proposed the IFA strategy to him.

Let’s assume Mr. Johnson is:
1. 35 years old
2. Purchasing a two-million-dollar permanent life participating insurance policy
2. Investing $130,145 annually for ten years
3. Has a loan interest rate of 5%

As you can see from the graph above, the black area is the cumulative premium paid by the bank. The grey area is the cumulative interest expense paid by the company. The yellow area is the excess death benefit after all premium and interest are paid.

When Mr. Johnson died at the age of 85, his death benefit would be 12.68 million. Over the years, he has paid 1.3 million in insurance premiums and 2.96 million in interest. This means he still can leave 8.42 million to his beneficiary. If all of the death benefits can be added to the corporate CDA account, his company can distribute the money tax-free to the beneficiary.

In summary, the Immediate Financing Arrangement (IFA) can help small business owners tackle many challenges. As the most advanced strategy in the financial field, you need to partner with the top financial advisors to navigate the process. If you want to learn more about this strategy, please visit ApexLife.ca.

Disclaimer

All content on this site is the information of a general nature and does not address the circumstances of any particular individual or entity. Nothing in the site constitutes professional, legal, tax, investment, financial, insurance or other advice, nor does any information on the site constitute a comprehensive or complete statement of the matters discussed or the law relating thereto. For more information, please visit ApexLife.ca.