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Help! IRAs Loaning to a Charity


Guest John P.
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Guest John P.

I am in a position to make a charitable donation. The charity has spoken to me about my IRA (self-directed) loaning the charity money who, in turn, will purchase a life insurance policy on my life with some or all of the death benefit proceeds going to the charity.

IF this is legal, it makes sense to me in my situation. Some of my questions are:

1) Does the charity have to pay my plan on-going interest?

2) Can the charity provide a balloon interest payment upon receipt of death benefits?

3) Can my IRA receive a portion of the death benefit (e.g., 2 million dollar death benefit....can my IRA upon my death receive, as an example, $700,000 with the remaining $1.3 million going to the charity?

4) Is this legal? It appears that it is, but my CPA is not familiar with this type of arrangement.

Ideally, I would like to do this AND have an agreement in place that my IRA would receive the initial premium (to fund the policy that is being loaned) back and a certain amount of the death benefit as an investment return. But can the charity do this OR do they HAVE to pay me interest during the period of time the loan is in force?

I am sure that I am missing a bunch of questions, but some general guidance is appreciated. If legal, this is something that I would seriously like to consider as it still provides a benefit back to my heirs but provides a real benefit back to the charity.

Thank you all so much. Also, I am assuming that if this CAN be done from an IRA, it could also be done from a 401K (I am self-employed)?

John

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There are two rules that come immediately to mind: 1) Disallowed investments for IRAs; and 2) Prohibited transactions.

Your question is whether the IRA may invest in a loan (note) to a charity. This type of investment is not, specifically, excluded from the types of investments an IRA may have (it's not a rug or work of art, metal or gem, stamp or coin, ect...). So, technically, such an investment is allowed; SUBJECT to certain overall rules.

A prohibited transaction is "ANY IMPROPER USE" of IRA assets. There is no specific list of items that would comprise an improper use, but there would be an easy argument that a loan to a chartity that does not bear a resonable rate of interest "may" constitute an improper use.

I answer the question in this manner as this is ultimately a measure of risk. You can find proponents of a argument (such is a recommendation you received from the charity) stating that everything is legitimate and perfectly legal. They are right, subject to accounting for every potential item that "may" constitute an improper use of IRA assets. If your strategy is eventually challenged by the IRS, this would be the likely ground on which the challenge would be made. They won't likely argue a note can be issued to a charity (as that is NOT listed as an item that an IRA may not invest in).

You "may" open a solo (k) plan and purchase a life policy. You may also make the charity a beneficiary for a portion of your death benefit under the plan (subject to spousal consent on that election). Not sure how that would impact your estate planning, but I believe there "may" be an unlimited charitable deduction on items gifted to charity. I'm not sure (as estate planning isn't my forte').

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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Since the charity proposed the idea, they had to have gotten it from somewhere. Have you asked them for more info? Ultimately on this potentially complex of a question, you should get proper legal advice from a known attorney and not from an internet forum.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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If you want to be a stickler about prohibited transactions, this is one. Carrying out your desire to help the charity is a use of IRA assets for a personal (i.e. not retirement savings) benefit. The more you make it look like not a conventional investment, the more you make it look like a prohibited transaction. For example, not having a conventional repayment schedule indicates that some other interest is being served. Your IRA is for your retirement, not for passing wealth to another person -- a scheme that does not pay until your death is another indication that something other than a benefit to your iRA is going on. I don't care what all of the life insurance junkies may argue about the accepted use of life insurance to fund retirement benefits. I am referring to some pretty strong evidence of an improper benefit being served by use of IRA assets. The DOL believes that intangible benefits are considered. They tend to be more difficult to prove.

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Guest John P.
If you want to be a stickler about prohibited transactions, this is one. Carrying out your desire to help the charity is a use of IRA assets for a personal (i.e. not retirement savings) benefit. The more you make it look like not a conventional investment, the more you make it look like a prohibited transaction. For example, not having a conventional repayment schedule indicates that some other interest is being served. Your IRA is for your retirement, not for passing wealth to another person -- a scheme that does not pay until your death is another indication that something other than a benefit to your iRA is going on. I don't care what all of the life insurance junkies may argue about the accepted use of life insurance to fund retirement benefits. I am referring to some pretty strong evidence of an improper benefit being served by use of IRA assets. The DOL believes that intangible benefits are considered. They tend to be more difficult to prove.

Thanks for your feedback and I understand. But, one question. I would think that there is not a "personal" benefit to me if the IRA is not receiving a benefit back until death. Obviously, if the benefit received was a portion of the death benefit, that amount corresponded into an interest rate would or could certainly be higher than if they paid an interest rate similar to a current CD. Am I not going down the right path? thanks again.

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Guest John P.
There are two rules that come immediately to mind: 1) Disallowed investments for IRAs; and 2) Prohibited transactions.

Your question is whether the IRA may invest in a loan (note) to a charity. This type of investment is not, specifically, excluded from the types of investments an IRA may have (it's not a rug or work of art, metal or gem, stamp or coin, ect...). So, technically, such an investment is allowed; SUBJECT to certain overall rules.

A prohibited transaction is "ANY IMPROPER USE" of IRA assets. There is no specific list of items that would comprise an improper use, but there would be an easy argument that a loan to a chartity that does not bear a resonable rate of interest "may" constitute an improper use.

I answer the question in this manner as this is ultimately a measure of risk. You can find proponents of a argument (such is a recommendation you received from the charity) stating that everything is legitimate and perfectly legal. They are right, subject to accounting for every potential item that "may" constitute an improper use of IRA assets. If your strategy is eventually challenged by the IRS, this would be the likely ground on which the challenge would be made. They won't likely argue a note can be issued to a charity (as that is NOT listed as an item that an IRA may not invest in).

You "may" open a solo (k) plan and purchase a life policy. You may also make the charity a beneficiary for a portion of your death benefit under the plan (subject to spousal consent on that election). Not sure how that would impact your estate planning, but I believe there "may" be an unlimited charitable deduction on items gifted to charity. I'm not sure (as estate planning isn't my forte').

Good Luck!

Erisa, thank you so much. Two quick questions....let's say hypothetically that a CD right now is paying me 2%. I understand what you are saying about an established rate of interest. That being said, I would then assume that a 2% or like 2.5% rate of interest could be charged as that seems to be in line with market rates...at least now. I would think if it could be established that these were legitimate numbers that I (along with the charity) would have some discretion on interest? Do you agree or disagree?

Second, since I am self-employed, are the rules not as stringent if I was establishing the 401K? For example, you mentioned that my plan COULD purchase the life insurance and list (with spousal consent) the charity as the beneficiary. Are the rules easier for the 401K? One big question I think of is....if my 401K could purchase the life insurance and in this crazy world I just want the highest death benefit, would the IRS question that I am not fulfilling my role as the Trustee in making prudent investment choices? On one hand, I can't see how they could judge what is prudent as some people believe that a life insurance policy would be a sound, conservative "preservation of wealth" investment tool.....but, who knows what the IRS would think.

Your thoughts? Thanks, again.

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If your IRA loans money to a charity, and the charity buys life insurance, and some of that life insurance benefit goes to anyone other than the charity, (your family members, for example) then I think you have a real problem. Congress has steadfastly refused to allow the use of IRA's to purchase life insurance. If the charity pays a portion of the death benefit back to your beneficiaries, this is indirectly purchasing life insurance with IRA funds, IMHO, and goes back to ERISAToolkit's discussion.

I'd suggest really strongly that you seek COMPETENT legal counsel before initiating any such transaction. Sometimes charities are bamboozled into promoting transactions that are questionable or incorrect by a life insurance agent who comes up with a scheme to make sales.

If ALL of the death benefits go to the charity, it might possibly be a different answer, but again, I'd recommend legal counsel.

Caveat Emptor!!

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Ditto on all of the comments on being careful and getting competent legal counsel.

Any time life insurance comes up as a solution, and especially in a convoluted scheme that involves borrowing, you need to take a giant step back and ask "what, exactly, am I trying to accomplish?" and then ask if there isn't a more direct way to do it - like just making a direct contribution. I mean, if you are lending money at a market rate of interest, then there's no gift element to that, and if you lend at a below market rate of interest, then there is some gift element to that, but it's not all that significant (assuming the lending is possible at all, which I think it is, but then I don't know about the life insurance part...it definitely seems to me that no proceeds could be coming back to your IRA or your heirs).

In other words, you started out by saying you are in a position to make a charitable donation, but it doesn't appear that you are actually donating much under the scheme as it is outlined.

Ed Snyder

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Guest John P.
Ditto on all of the comments on being careful and getting competent legal counsel.

Any time life insurance comes up as a solution, and especially in a convoluted scheme that involves borrowing, you need to take a giant step back and ask "what, exactly, am I trying to accomplish?" and then ask if there isn't a more direct way to do it - like just making a direct contribution. I mean, if you are lending money at a market rate of interest, then there's no gift element to that, and if you lend at a below market rate of interest, then there is some gift element to that, but it's not all that significant (assuming the lending is possible at all, which I think it is, but then I don't know about the life insurance part...it definitely seems to me that no proceeds could be coming back to your IRA or your heirs).

In other words, you started out by saying you are in a position to make a charitable donation, but it doesn't appear that you are actually donating much under the scheme as it is outlined.

Bird, thanks for the words. I truly appreciate it.

I guess what I meant to say as compared to "donation" is that I know and WANT a benefit back to the IRA. But, I also know that if I lived to 110 that the charity could pay more out to me than what they would receive...and I would not want that, either.

My thinking....probably way too flawed lol....is that if a 2M death benefit was secured through the loan, selfishly, the IRA would like to receive its premium back plus a set amount...that way everyone knows what they are getting and can plan accordingly. Using totally hypothetical numbers, if a $500,000 loan purchased a $2M death benefit, the IRA would like to secure back its $500,000 plus, let's say, $300,000. IF the IRA has to charge interest during the term, that's okay too. Just wanting to know the options. I think everyone is in general agreement that after securing legal counsel, that it would not be a problem doing the loan....question is whether it has to be serviced with interest "during" the term vs. at the end, etc. Thanks, again.

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After further thought, the charity and life insurance part of this is a red herring.

The question is: can a self-directed IRA loan money to an unrelated entity? Probably yes, subject to structuring the transaction correctly. Also note the word unrelated; if you're on the board or serve in too close of a capacity w/ the charity then you may start having issues.

1) Does the charity have to pay my plan on-going interest?

My non-expert opinion is: yes, they should pay both principal and interest at a commercially reasonable rate. But obtain legal advice.

2) Can the charity provide a balloon interest payment upon receipt of death benefits?

My non-expert opinion is: no, it's not commerically reasonable to permit a balloon payment for either principal or interest when it's an unsecured loan. But obtain legal advice.

3) Can my IRA receive a portion of the death benefit (e.g., 2 million dollar death benefit....can my IRA upon my death receive, as an example, $700,000 with the remaining $1.3 million going to the charity?

My non-expert opinion is: no, the insurance is outside of your transaction w/ the charity. The charity can payoff the loan w/ the insurance proceeds (a lump sum payoff w/out penalty is commercially reasonable). But obtain legal advice.

4) Is this legal? It appears that it is, but my CPA is not familiar with this type of arrangement.

Again, the charity and life insurance parts of this are a red herring. You need to research making loans out of a self-directed IRA... and obtain legal advice.

Nothing on this forum should be construed as legal advice... especially not mine.

Of course, you could just put $500K into a separate IRA account and work w/ the IRA holder to craft a beneficiary designation that balances giving to the charity and to your beneficiaries. Perhaps: $500K plus 1/2 of any excess to Charity A with the remainder to Beneficiaries B, C or D. (And this is doubly good because you can always change the designation if things go sour w/ the charity.)

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Yeah, this is where my thought process was going although as I reread my post I'm not sure I stated it very well. But this contemplates that all of the excess death benefit (over and above the required repayment of principal and interest to the IRA) is to be retained by the charity. It can't go back to the IRA.

I'm rather dubious that this scheme would satisy RMD options if the individual lives to ripe old age, but I really didn't think that aspect through - just a knee-jerk reaction.

Anyway, legal/tax counsel can advise you on all of this

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Wow, great commentary by masteff, excellent link to article by Tom, and Belgarath makes a great point about RMDs in later years* (I feel like a play-by-play commentator). Nothing much to add.

*OK, I'll expand on this in case it's not obvious - the RMD is around 4% in the first couple of years, but increases. It's close to 10% at age 90. You have to make sure you have liquid assets to satisfy the requirements - if you're only getting 2% or so from the charity, the money needs to come from somewhere else. As long as you don't lend 100% of the IRA to the charity and keep 10, 15, 20% (?) liquid, that problem can be planned around. Bets are off if you live to 100, when life expectancy is 6.3 (15.8% RMD) - and the effective percentage increases significantly thereafter.

Ed Snyder

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The charity ... will purchase a life insurance policy on my life with some or all of the death benefit proceeds going to the charity.

In addition to the cautions stated above, is there an insurable interest here?

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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  • 1 month later...

This has been an interesting thread. I'm not sure what is the purpose of this complicated scheme? What is the charity trying to get out of it besides a donation? What does the IRA holder expect to achieve? I think the prior authors have talked about related parties, RMDs, prohibited transactions and some of the other pitfalls.

I would also raise the issue of failure to execute the plan. What happens if this runs out 10+ years and the mgmt team at the Charity has been 100% replaced?

Second point - you can't readily work out all the possible scenarios that might occur between now and some unknown date in the future. Ten years from now...what are the tax rates, inheritance taxes, allowed charity deductions?

You could readily get stuck in a complex agreement that subsequently goes bad because of changes in public policy and taxes.

I would be doubly concerned if the local charity came up with this idea by themselves.

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is there an insurable interest here?

I was mildly surprised to see that the article Tom cited says yes.

After further thought, I still have a concern about insurable interest. Note that the cited article refers to the donor as a "regular" donor to the charity. What if that "regular" characteristic does not exist? I don't claim to have an answer, just some caution.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Having had conversation just last night about insurable interests, I got to digging. In large part, state insurance law will prevail on who has an insurable interest. I found it interesting in reading Oklahoma's statute which includes the following:

"Life insurance contracts may be entered into in which the person paying the consideration for the insurance has no insurable interest in the life of the individual insured, where charitable, benevolent, educational or religious institutions, or their agencies, are designated as the beneficiaries thereof. In no event shall an individual be named as a beneficiary. In making these contracts, the person paying the premium shall make and sign the application therefor as owner and shall designate a charitable, benevolent, educational, or religious institution, or an agency thereof, as the beneficiary or beneficiaries of the contract. The application or any subsequent change of beneficiary designation shall be signed by the individual whose life is to be insured. These contracts shall be valid and binding among the parties, notwithstanding the absence otherwise of an insurable interest in the life of the individual insured."

This also gives us a better answer to the OP's question about having his IRA get part of the proceeds... at least under Oklahoma law, it's expressly prohibited.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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  • 4 weeks later...

From the article that Tom linked us to, one thing to point out is a statement in the article: "...The IRA owner could either leave the IRA to family members or transfer the IRA balance at death to Favorite Charity..."

Depending on when the change of beneficiary to leave the IRA balance at death to Favorite Charity is done, there could be a cause for prohibited transaction:

(1) If done before the loan was done, then it is prohibited as an IRA cannot invest in any party having any direct or indirect beneficial interest with the IRA

(2) If done after the loan is done, then there could be an issue with the loan itself, as it could be argued that this is a self-loan, which is not an investment, and loans are prohibited from IRA's...

My 2 cents in addition to all the other comments by others...

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