Key Question for Canadians
How can you make sense of the complex terminology surrounding Immediate Financing Arrangements (IFAs) to determine if this strategy is the right tool to enhance your financial plan?
- A Common Language: An IFA is not a product but a complex, multi-decade strategy built by specialists. This glossary provides the clear definitions you need to have productive and informed discussions with your advisory team.
- The Core Mechanism: The strategy uses a permanent life insurance policy (generally participating whole life) as collateral for a third-party loan. This allows you to turn a protective asset into a productive one by using the loan to invest in an income-producing business or asset.
- The Strategic Benefit: An IFA’s value comes from its tax efficiency. You can benefit from key advantages like deducting loan interest and a portion of the insurance cost. For your corporation, the tax-free death benefit can repay the loan and create a significant credit to the Capital Dividend Account (CDA), enabling a powerful, tax-efficient transfer of wealth.
The Immediate Financing Arrangement (IFA) is a sophisticated financial strategy, and understanding its specific terminology is a crucial step in evaluating its potential. An IFA is not a product you can buy, but rather a complex, multi-decade strategy built and maintained by a team of specialists.
This glossary is designed to make you fluent in the language of IFAs. It acts as a shared resource, whether you are considering an IFA for yourself or for a client, empowering you to have more productive and informed discussions with your advisory team.
Once you are familiar with the what, the natural next question is the why (or why not). After reviewing these terms, we recommend reading If an IFA Is So Good, Why Isn’t It for Everyone? to understand the specific criteria that make a candidate suitable for this strategy.
Page Contents
How to Use This Glossary
This resource is organized thematically to build your understanding from the the basics. We cover:
- Foundational Concepts: The core principles that drive the IFA strategy.
- The Key Players: The essential members of any IFA structure.
- The Building Blocks: The specific products that form the foundation.
- The Tax & Legal Engine: The provisions in Canadian tax law that make the IFA possible.
- Managing the Risks: The language used to describe and manage potential challenges.
- Historical & Conceptual Context: Understanding how the IFA relates to other leveraged strategies.
1. Foundational Concepts
These are the core economic and strategic principles upon which the entire IFA structure is built.
Immediate Financing Arrangement (IFA): A Canadian financial strategy where a permanent life insurance policy is used as collateral to secure a loan from a third-party lender. The loan proceeds are then used to invest in an income-producing business or asset.
- Why it matters: An IFA provides a mechanism to access the value locked inside a policy, turning a protective asset into an active one. For a comprehensive overview, see our Foundational Guide to Immediate Financing Arrangements.
Capital Efficiency: The principle of making a single dollar perform multiple jobs. In an IFA, the capital used for a life insurance premium simultaneously funds a death benefit for estate protection and builds cash surrender value that unlocks immediate liquidity for investment.
- Why it matters: An IFA resolves the classic dilemma of wanting insurance protection without having capital sit passively in a policy.
Leverage: The use of borrowed funds to increase the potential return of an investment. The IFA is a leveraging strategy that uses the insurance policy’s cash surrender value to access capital.
- Why it matters: It’s a powerful tool that magnifies both gains and losses, requiring a high degree of comfort with long-term risk. For a deeper dive, see our Accountant’s Guide to Leverage: IFA vs. Conventional Investment Loans.
Net Estate Value: The total value of an estate passed on to beneficiaries after all liabilities, including taxes, have been paid.
- Why it matters: A well-executed IFA is designed to increase this value. Upon death, the tax-free insurance proceeds first repay the loan, with the significant remainder flowing tax-free to the beneficiary. This can be a key tool for creating a surplus in the Capital Dividend Account, a concept we explore in the IFA-Enhanced CDA: A Foundational Guide for Accountants.
2. The Key Players: Your IFA Team
An IFA is a multi-party structure that requires precise coordination between three main entities, all guided by your core advisory team.
Policyowner (Borrower): The individual or corporation that owns the life insurance policy, pays the premiums, and borrows against it.
- Why it matters: This is the central actor who bears the ultimate financial risk and is responsible for making all key decisions.
Insurer (Insurance Company): The financial institution that issues the life insurance policy, the foundational asset for the strategy.
- Why it matters: The insurer’s financial strength and dividend performance are critical to the long-term stability and growth of the collateral.
Lender (Restricted Financial Institution): The third-party lender, such as a bank or credit union, that provides the collateral loan.
- Why it matters: The terms, flexibility, and stability of the lender relationship are as important as the insurance policy itself. Using a qualified RFI is also a requirement for certain tax deductions.
The Core Advisory Team: An IFA is “built, not bought”, requiring a coordinated team of specialists.
- Why it matters: As detailed in The IFA Core Advisory Team, integrated advice is crucial to prevent structural flaws that prevent long-term success.
3. The Building Blocks: Insurance & The Loan
These are the primary financial instruments and concepts related to an IFA.
Collateral Loan / Leveraged Loan: A loan secured by the Cash Surrender Value (CSV) of the life insurance policy.
- Why it matters: This instrument provides the immediate liquidity that is the defining feature of the IFA. It is typically a variable-rate demand loan, which carries specific risks.
Policy Loan: A loan taken directly from the insurer, secured by the policy’s cash surrender value.
- Why it matters: This is the primary borrowing method in the Infinite Banking Concept, not a third-party IFA. The interest on a policy loan is generally not tax-deductible in the same manner, a key structural difference.
Participating (Par) Whole Life Insurance: The preferred type of permanent life insurance for an IFA. It offers guaranteed minimum cash values and the potential to earn dividends.
- Why it matters: It creates a stable, predictable, and growing collateral base that lenders favour. This stability is why we call it the Engine for an IFA.
Universal Life (UL) Insurance: A type of permanent life insurance that offers flexible premiums and a cash value that grows based on the performance of underlying investment accounts chosen by the policyowner.
- Why it matters: While it is a form of permanent insurance, UL is generally less suitable for IFAs because its cash value is not guaranteed and can be volatile, making it less reliable as collateral.
Cash Surrender Value (CSV): The equity or savings component within a permanent life insurance policy that you would receive if you terminated the policy.
- Why it matters: In an IFA, the CSV is the most important asset, as its value directly determines the amount of leverage available to the borrower.
Collateral Assignment: The legal agreement that temporarily assigns limited rights in the insurance policy to the lender as security for the loan.
- Why it matters: This legal instrument is the critical link that connects the insurance policy to the loan, providing the lender with the security they need.
Death Benefit: The tax-free sum paid by the insurer upon the death of the life insured.
- Why it matters: The death benefit serves two vital functions: first, to repay the loan in full, and second, to deliver the net proceeds to the beneficiary.
4. The Tax & Legal Engine: How the IFA Creates Value
The economic viability of an IFA is directly dependent on these provisions within Canada’s Income Tax Act.
Adjusted Cost Basis (ACB): The policyowner’s tax cost of the insurance policy, generally calculated as cumulative premiums paid minus the cumulative net cost of pure insurance.
- Why it matters: This figure is crucial for determining the taxable gain if a policy is surrendered and for calculating the credit to the Capital Dividend Account upon death.
Capital Dividend Account (CDA): A special corporate account that tracks tax-free surpluses, which can be paid to shareholders as tax-free dividends.
- Why it matters: For a corporate IFA, the death benefit creates a large credit to the CDA, providing a uniquely powerful mechanism for tax-efficient wealth transfer. We explore this in our Foundational Guide for Accountants on the IFA-Enhanced CDA.
Interest Deductibility (The “Purpose Test”): A cornerstone of the IFA’s efficiency, this is the requirement that borrowed funds must be used for the purpose of earning taxable income from a business or property.
- Why it matters: Satisfying this test allows the loan interest to be deducted, significantly lowering the net cost of the strategy. For a detailed review, see our Accountant’s Companion to Interest Deductibility.
Collateral Insurance Deduction: A potential second tax deduction that allows the policyowner to deduct a portion of the policy’s cost of insurance.
- Why it matters: This provides another layer of tax efficiency, further reducing the net after-tax cost of funding the life insurance.
5. Managing the Risks: Terms for Your Due Diligence
Understanding these terms is key to appreciating and managing the risks inherent in a long-term leveraged strategy.
Annual Review: The lender’s periodic review of the borrower’s creditworthiness and the collateral value.
- Why it matters: Since most IFA loans are demand loans, the lender retains the right to change the terms or call the loan, representing a key form of counterparty risk. This is a central component of IFA Lender and Credit Risk.
Interest Rate Risk: The risk that a rise in the lender’s prime rate will increase the cost of borrowing.
- Why it matters: This increases the cost of the strategy and is a primary long-term risk that requires careful Stress-Testing for Correlated Market Risks.
Loan Repayment (Exit Strategy): The plan for how the collateral loan will ultimately be repaid.
- Why it matters: The primary exit strategy is the tax-free death benefit. However, it’s crucial to understand the implications and options for an early exit, a topic we cover in Unwinding an IFA: Options for an Early Exit.
6. Historical & Conceptual Context
10-8 Strategy: A predecessor to the modern IFA that was popular prior to 2013. This strategy involved an arrangement with high, prescribed interest rates that was ultimately eliminated by legislative changes.
- Why it matters: Understanding the 10-8 strategy’s flaws helps clarify why the modern IFA is structured differently to be a more sustainable, long-term strategy. For a detailed comparison, see our article on IFA vs. 10-8: Lessons Learned.
Infinite Banking Concept® (IBC): A strategy where an individual uses a dividend-paying whole life policy as their personal “bank”, typically borrowing against it via policy loans from the insurer.
- Why it matters: This term is often incorrectly used in marketing. Understanding that a true Canadian IFA uses a third-party lender is critical to evaluating its unique tax benefits. For a detailed analysis, see our IFA vs. Infinite Banking: A Made-in-Canada Clarification.
Premium Financing: A broad term for any arrangement where funds are borrowed to pay for life insurance premiums.
- Why it matters: This is fundamentally different from an IFA. For an IFA’s loan interest to be tax-deductible, the premiums must be paid with unborrowed capital. Borrowing to pay premiums can render the loan interest non-deductible.
Your Next Step: From Glossary to Strategy
Fluency in these terms is the foundation, but the real value comed from applying them to your unique situation. An IFA is not a one-size-fits-all solution; it’s a tailored strategy that must be carefully engineered.
If you’re ready to move from definition to discussion, we’re here to help translate these concepts into a clear, actionable plan for your business or estate. Schedule a chat to explore how an IFA could be structured to meet your specific objectives.
At Taxevity Insurance, we’re passionate about bringing clarity to complex financial decisions. Let us empower you with personalized strategies to achieve your goals. We focus on life and health insurance solutions to protect your business, your family, and your legacy.
