IRA Strategies Your Mother Never Told You – Part I

by Randy A. Fox

Advisors often find themselves in situations where they are asked for advice regarding efficient uses of IRAs or other qualified plans. There are a number of creative solutions that advisors may deploy depending on what the client is trying to accomplish now and in the future. This series of posts will explore some interesting and little-known strategies that advisors can learn and adopt to better help maximize the value of the IRA funds of their clients.

Consider the following case facts. A Carol, age sixty-two, has an IRA balance of $1.6 million. She is very charitable and wants to make gifts to her church to help with a current building project. She is too young to participate in the Qualified Charitable Distribution (QCD) and taking money out of her IRA, paying the taxes, and making a gift with little or no tax benefit doesn’t make sense either. What other options are there?

Carol has her IRA make a loan of $1million to her church at a competitive interest rate. The loan is interest only with a balloon payment due at Carol’s death. 

IRAs cannot own or purchase life insurance. However, the church can purchase life insurance on Carol’s life. While they use the proceeds for its building project, the life insurance will guarantee the principle repayment to the IRA at Carol’s death.

In Private Letter Ruling 200741016 (July 12, 2007), a taxpayer proposed lending money from an IRA to a charity with a reasonable interest rate and with payment of the loan due upon his death. The charity anticipated using part of the loan proceeds to purchase a life insurance policy on the life of the IRA owner. The Service concluded that the IRA loan was not a “prohibited transaction” under the IRA prohibitions contained in Section 4975. Furthermore, the Service concluded that the charity’s purchase of a life insurance policy was not a “prohibited investment in insurance” under Section 408(a)(3).” The IRS said there was no problem with either.

Implications.

#1 – Benefit from lifetime charitable use of IRA assets. By lending money from an IRA to a charity, a donor can allow the charity to have the lifetime use of her or his IRA assets. This is more tax-efficient than receiving a distribution from the IRA and then donating or lending it to the charity. And, further, the donor doesn’t have to wait until age 70 ½ to utilize QCDs to fund their charitable purpose. Also, since the funds are only a “loan” the beneficiaries will still inherit the IRA proceeds.

A Donor might also want to make a charitable bequest of those IRA assets to the charity at death in order to cancel the debt. If the donor is uninsurable, loaned IRA assets would still allow the charity to use the funds while the donor is living. Upon death, the charity would receive its own promissory note and the debt would be canceled.

#2 – IRAs are prohibited from owning life insurance. This arrangement permits IRA dollars to be indirectly used for the purchase of insurance with “pre-tax” dollars.

#3 – Plan for RMDs. Required minimum distributions are calculated on the entire value of the IRA. Plan to keep enough liquid assets to maintain distributions. Optionally, make the note a demand note or allow the IRA owner to forgive a portion of the note annually to meet RMDs. 

Planning tip: The Donor probably needs a self-directed IRA to do this since conventional IRA trustees and custodians usually limit investments options and might not consent to a large loan to one charity. Therefore, from an existing IRA, or qualified plan, the donor should rollover the assets to their newly created, self-directed, IRA. 

The self-directed IRA custodial agreement authorizes the IRA custodian to invest IRA assets via a loan directly to the charity (and not a check payable to the charity but mailed to the Plan Participant (Donor)). 

The next article in the series will examine a method to increase the value of the IRA assets, while minimizing taxes.