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Permanent life insurance is no longer just about providing security and cash for beneficiaries after death. It’s a strategic wealth generation product advisers can recommend to their clients for low interest loans through an immediate financing arrangement (IFA).
Specifically, an IFA leverages the universal or whole life policy clients own so they can use it as collateral to obtain a loan. The funds can be used toward their investment portfolio, business or to purchase real estate.
What makes IFAs appealing is how they’re structured and the flexibility they offer. Once clients acquire a policy, they can apply for an IFA. The client pays the premium at the beginning of the policy year and can borrow up to 100 per cent of the cash value immediately at a low interest rate, often at or just above the prime rate.
The borrowing process can be repeated as long as premiums are paid, which can be for 10 to 20 years, depending on the policy. Repayment of the loan is also flexible, allowing for regular payments, lump sums or full repayment if the client has generated enough cash.
When the client passes away, any outstanding loan amount is paid out from the death benefit, which is tax-free, and the rest of the money goes to named beneficiaries.
IFAs have been around for about 20 years, but they’re gaining popularity thanks to the growing number of high-net-worth Canadians using them, says Jeff Fray, vice president of insurance services at Richardson Wealth Ltd. in Toronto. Still, IFAs aren’t for everyone.
“They’re suited for a niche segment,” Mr. Fray says. “Someone who is sophisticated and is comfortable with leverage.”
That’s because IFAs are considered to have higher risk as clients who qualify are not only borrowing money, they also need to have the money to be able to pay the premiums and the interest, he says.
High annual premiums
Mr. Fray says that clients who use IFAs are often paying hundreds of thousands, if not millions, of dollars in annual premiums.
Locking up that amount of money for a decade or two in premiums can cause trepidation in clients, says Michael Pilz, head, national sales, cash surrender value lending, at Equitable Bank in Toronto. The lowest annual premium he’s seen is $30,000 a year.
“Wealthy Canadians are often business owners and the ones who have this large insurance need and can project out to end-of-life and estate planning,” he says. “While everyone is on board with having insurance, the policy holder looks at the premium amount and they [may] think they don’t want to lose that to the policy.”
That’s why IFAs are appealing to clients because they can get the insurance that they want or need, but they still have the liquidity needed to finance business operations in one product.
Mr. Pilz says IFAs are for people who are in capital-intensive businesses and are accustomed to using leverage as a way to fund growth.
But the benefits can also outweigh the risks. Apart from the tax-free benefits upon death, there are other tax incentives.
Clients pay interest and that can be deducted against that loan, Mr. Fray says, but they need to have the income to support the deductions. That’s why IFAs are suited to high-net-worth clients.
While IFAs are well-known in the insurance industry, they’re becoming increasingly popular among advisers and their clients.
“We hear from life insurance companies who say, ‘We have advisers who are desperate for more knowledge because clients are coming and asking them about it,’” says Scott Davidson, manager, stakeholder relations, at Langhaus Financial, a provider of insurance-backed lending in Toronto.
He says the investment aspect of the whole insurance policy has made it a more attractive asset class.
Michael Godsoe, chief executive officer of Langhaus Financial, says the company currently has $300-million in its book and is expecting to reach $400-million by the end of 2022. He expects to see exponential growth in the adoption of IFAs.
Insurance is a $1-trillion business in Canada and Mr. Godsoe estimates that “there’s about $60- to $80-billion tied up in a lot of life insurance policies right now.”
Mr. Fray also says there’s great opportunity for growth in this space, but adds that advisers need to work with their clients to make sure IFAs are the right tool for them.
“The clients who use IFAs, they get it. They understand the risk, leverage, and know how to use capital,” he says.
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