According to the Federal Reserve, IRAs now have passed $3 trillion in value and are moving toward $4 trillion. Millions of IRA owners are also charitable donors and may be interested in a plan to benefit charity while still receiving life income from an IRA.

A potential "benefit to charity with life income" strategy was described in PLR 200741016. It involves a loan from an IRA to a charitable organization with the interest payments used to fund the IRA required minimum distributions. This option exists with self-directed IRAs and custodians who are willing to participate in the transaction.

IRA Loan In PLR 200741016

In PLR 200741016 an IRA owner desired to make a 20 year term loan with annual 5% interest payments to Church B. The self-directed IRA custodian was willing to transfer funds to Church B in exchange for both the 20 year/5% note and a collateral assignment on an insurance policy.

Church B planned to use a portion of the funds to acquire a life insurance policy on the life of IRA owner. Church B will have full ownership and control of the policy and will be the beneficiary. As part of the agreement for the loan, Church B will complete both the 20 year/5% promissory note and provide the IRA custodian a collateral assignment of the proceeds to the life insurance policy.

At the end of 20 years or the earlier demise of the donor (and maturity of the life insurance policy), Church B will repay the loan principal amount to the IRA custodian. IRA owner plans to take required minimum distributions (RMDs) from the IRA during his lifetime. Loan interest payments will provide funds for the RMDs.

The IRA owner requested a ruling that the loan was not a prohibited transaction and that the IRA did not make a prohibited investment in the life insurance policy.

Sec. 408(a)(3) prohibits an IRA from investing in life insurance. Sec. 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.

Because Church B is not a disqualified person, the IRS determined that the loan to Church B is permissible. Second, because Church B is the owner of the policy with full rights of ownership and is the policy beneficiary, the IRA does not own a prohibited life insurance investment. While a PLR is not a precedent and applies only to that taxpayer, the ruling suggests that an IRA loan and insurance plan may be permissible.

IRA Loan Strategies

There are three potential options or strategies that could be involved with a loan from an IRA. These are a loan to the charity with a bequest of the note, a plan similar to PLR 200741016 in which the charity uses the funds to acquire a life insurance policy on the IRA owner and an option in which the donor not only loans the funds to the charity but also makes a cash gift of the required minimum distributions.

I. IRA Loan Plus Bequest

An IRA owner may make a loan to a public nonprofit. Under Sec. 4975(c)(1)(B), a loan to a disqualified person is prohibited. Sec. 4975(e)(2) lists the disqualified individuals. Among those parties would be a fiduciary, an employer, an employer organization, an owner of 50% or more of the equity or beneficial interests in an entity or a member of the family or controlled business entity. The nonprofit organization is not listed. The public nonprofit organization is not a member of the prohibited list and therefore a loan is permissible.

However, there is a basic requirement that loans pay a fair rate of return. Each month the IRS publishes a revenue ruling that lists the applicable federal rate for loans. Typically, a loan from an IRA to a nonprofit will be a long-term loan with annual payments. Therefore, the applicable federal rate for annual payment long-term duration loans should be the interest payment on the IRA loan.

IRA Loan Example - Capital Building Campaign

Assume that IRA owner is a supporter of Favorite Charity. Favorite Charity needs $1 million to complete the capital building campaign and construct a new facility. IRA owner has $2 million in her IRA and lends $1 million to Favorite Charity on a 40 year note with interest-only payments of 5%. Favorite Charity has substantial assets and endowment. Therefore, the unsecured note is deemed to be a prudent investment for the IRA.

Upon receipt of the $1 million, Favorite Charity completes the capital campaign and builds the new facility. Each year, Favorite Charity makes an annual payment of $50,000, (the 5% interest) to the custodian for IRA owner. These funds are used as part of the IRA required minimum distribution. Because IRA owner desires to support Favorite Charity, she designates Favorite Charity as the primary beneficiary of $1 million of her IRA. When IRA owner passes away, the $1 million note will be returned to Favorite Charity.

Because IRA owner is age 75, it is unlikely that she will survive to age 115. However, if IRA owner were to survive for the 40 year duration, Favorite Charity would then need to make the $1 million payment back to the custodian of IRA owner at that time.

II. IRA Loan Plus Insurance Policy

In a manner similar to PLR 200741016 the IRA owner could combine a loan with a purchase of insurance by the nonprofit.

Once again, the loan from the custodian of IRA owner to Favorite Charity is permissible, so long as the loan bears an appropriate interest rate. IRA owner contemplates creating a 30 year interest-only loan with a 5% rate and annual payments. IRA owner divides her $2 million IRA into $1 million that she will retain and $1 million that will be loaned to Favorite Charity. The treasurer of Favorite Charity signs the $1 million promissory note with a term of 30 years and 5% annual interest payments.

Because Favorite Charity is permitted to invest the funds as desired, Favorite Charity then acquires a life insurance policy on IRA owner. IRA owner is a regular donor to Favorite Charity and under state law Favorite Charity does have an insurable interest in IRA owner. Because Favorite Charity has ownership of the insurance policy, full control with respect to the policy and is the beneficiary, the IRA is not making a prohibited life insurance investment under Sec. 408(a)(3).

When IRA owner passes away, Favorite Charity receives the proceeds of the insurance policy and makes the repayment of the note to the IRA. The IRA owner could either leave the IRA to family members or transfer the IRA balance at death to Favorite Charity.

If the IRA owner leaves the IRA to family members, then he has enabled the charity to benefit from any excess earnings on the fund during his lifetime. If the IRA owner also leaves a bequest of the fund to the charity, then the charity receives both the benefit of excess earnings during life and the principal from the IRA when the owner passes away.

One concern about the plan is the potential for unrelated business taxable income. In Mose and Garrison Siskin Memorial Foundation, Inc., v. United States, 790 F.2d 480 (6th Cir. 1986), the charity owned 800 insurance policies and desired to increase total return. Policy loans at 5.5% interest were withdrawn and invested at approximately 10%, producing an annual profit of 4.5%. The court determined that because the loans were "acquisition indebtedness" under Sec. 514(c), that profit was unrelated business taxable income.

Similarly, because the loan from the IRA owner to the charity may be invested and produce income, there is a potential for Sec. 514(c) unrelated business taxable income on the debt-produced revenue. If all of the payments from the owner are invested in the insurance policy, it is possible that the exception on death benefits proceeds of life insurance would eliminate the unrelated business taxable income issue. However, if there are any other earnings or capital gains during the life of the owner that can be traced to the investment of IRA loan proceeds, then acquisition indebtedness and unrelated business taxable income would apply.

III. Donor Gift of Required Minimum Distributions

If a donor decides to create a self-directed IRA with a cooperative custodian and make loans to a nonprofit, there still is a requirement for the donor to receive the annual required minimum distribution (RMD). The RMD under the Uniform Table starts at approximately 3.8% at age 71 and increases with age.

There are two potential tax-saving options for the donor. The donor could withdraw the RMDs and then make a cash gift each year to charity. Provided that the donor may do so without exceeding his or her 50% of adjusted gross income deduction limit, the gift would be fully deductible in that year.

Alternatively, if the Sec. 408 option to give up to $100,000 in a qualified charitable distribution (QCD) is applicable for a given year, the donor can transfer the RMD amount (up to $100,000) directly to charity through a QCD. In this case, the donor benefits because his or her adjusted gross income was not raised to a higher level, thus triggering potential phase-ins of higher rates and phase-outs of various benefits.


Creative IRA Loan Planning

The opportunity for an IRA owner to make a reasonable interest loan to a nonprofit opens up several new creative planning strategies. For IRA owners with substantial balances who desire to benefit charities now instead of waiting to transfer the balance at their demise, the loan strategies may be very attractive.

The IRA charitable loan with a revocable beneficiary designation to Favorite Charity is reasonably straight-forward. In the vast majority of cases, it will result in an immediate transfer of benefits to charity.

For the more sophisticated and creative donor, the IRA loan with the charity purchasing a life insurance policy may also be a desired option. It should be emphasized that this option potentially may subject the charity to unrelated business income tax on any net income from the loan.