Strategies for IRA Distributions to Family & Charity – (Last) Part IV


IRA CHARITABLE STRATEGIES

Loan of IRA to Charity
For those who would like to use their IRA dollars to make a large charitable impact, there is another creative strategy that enables an IRA owner to make a large significant gift to charity during life without taking a taxable distribution. This strategy was described in PLR 200741016 and involves loaning funds from a self-directed IRA to a charitable organization with a fair annual rate of return or interest rate with payment to be due upon the death of the owner. The charity will use part of the loan proceeds to secure a life insurance policy on the life of the IRA owner. Then, upon the death of the IRA owner, the charity will use the death benefit to pay the outstanding loan amount. This option exists for IRA owners who have self-directed IRAs and can therefore invest in alternative assets outside of the approved investments that are available to traditional IRA owners. Ultimately, because the loan is an investment of the IRA, rather than a distribution, the transfer of funds is not taxable to the IRA owner. With this plan, an IRA owner can make a transfer above and beyond the $100,000 IRA charitable rollover limit and avoid paying taxes on the distribution or including the distribution as income for tax purposes.

Example 5:

John graduated many years ago from State University. He wants to give back to the University by making a major gift but lacks substantial liquid assets to do so. His IRA is valued at $5 million. John considers taking a $2 million distribution from his self-directed IRA and then making a gift to the University, but he does not want the large distribution to be included in his income for tax purposes. He approaches his advisor, Tom, for a charitable solution.

Tom suggests that John direct his IRA to issue a $2 million, 20-year interest-only loan to the University. Because the loan must pay a fair rate of return, the rate on the loan will be based on the applicable federal rate for loans, as published by the IRS. The loan will be payable upon the earlier of the term or John’s death. John will still have to take RMDs from his IRA. He may choose to gift up to $100,000 of his RMD to the University as a qualified charitable distribution each year.

The University will be required to make annual interest payments on the loan. As such, the University will set aside $600,000 of the funds received in order to make interest payments on the loan. The University will then use $1 million of the loan for future premiums on a life insurance policy that it takes out on John’s life. The remaining $400,000 will be used by the University for its current needs. When John passes away, the University will receive the proceeds of the insurance policy and repay the note to the IRA.

In PLR 200741016, the IRA owner requested two rulings based on the strategy described above. First, he requested a ruling that the loan from the IRA to the charity was not a prohibited transaction. Section 408(e)(2)(A) indicates that an IRA owner may not participate in a prohibited transaction, such as a Sec. 4975(c)(1)(B) loan of money to a disqualified person. In this case, the IRS determined that the charity was not a disqualified person in relation to the IRA owner because the IRA owner was not a board member or employee of the charity, nor did the IRA owner have control or a financial interest in the charity. As such, the IRS concluded that this arrangement is not considered a prohibited transaction that would cause termination of the IRA.

The taxpayer also requested a ruling that the strategy described above was not a prohibited investment in insurance by the IRA. Under Sec. 408(a)(3), an IRA is prohibited from investing in life insurance. Here, the IRS found that because the charity, not the IRA, is the owner of the life insurance policy with full rights of ownership and is the policy beneficiary, the IRA does not own a prohibited life insurance investment. Therefore, this arrangement was not a prohibited investment under Sec. 408(a)(3). As such, the IRS found that the loan from the IRA and the insurance strategy were permissible. While a PLR is not a precedent and applies only to that taxpayer, the ruling is useful in indicating how the IRS may rule based on a set of facts.

Loan of IRA Coupled with Bequest
There is an additional charitable IRA strategy that involves a loan from an IRA to a charitable organization (as described above) but does not include a life insurance policy. With this plan, the owner’s self-directed IRA loans assets to a charitable organization and designates the charity as beneficiary of the IRA upon the death of the owner. The IRA owner makes IRA charitable rollover gifts to the charity during life to enable the organization to fund the interest payments on the loan. When the IRA owner dies, the charitable beneficiary will be able to satisfy the debt using the assets it receives from the IRA. This is a great option for a charitably inclined individual whose favorite charity is in need of capital for a current campaign or project.

Example 6:

Jane wants to give a substantial sum to her favorite charity’s capital campaign so that it can begin construction on a new building. She is considering making a $1 million gift, but she lacks liquid assets to do so. She has a self-directed IRA, but does not want to take a large taxable distribution this year. Her advisor suggests that she direct her IRA to issue a $1 million loan with a fair rate of return to the charity.

Upon receipt of the $1 million, the charity is able to immediately put the funds toward the construction of its new building. The donor can make additional gifts each year in the form of IRA charitable rollovers to help the charity pay the annual interest payments on the loan. Jane also designates the charity as beneficiary of her IRA so that, upon her death, the charity can satisfy any unpaid interest and principal on the loan.

If you would like to support a favorite Catholic church, school, or ministry through an IRA contact Scott Hartman (614-443-8893 or shartman@catholic-foundation.org) for additional details.