Susan is a faithful supporter of her favorite charity. She has a $200,000 IRA and her RMD this year is 5%, or $10,000. Because she has substantial other income and does not itemize her deductions, Susan directs her IRA custodian to make a qualified charitable distribution to her favorite charity in the amount of $10,000. Because the full RMD is transferred to a qualified charity, Susan will owe no taxes on her RMD and will not be required to include it in her income for tax purposes. Because Susan takes the standard deduction, the IRA rollover reduces her taxable income by $10,000. Based on her income tax rate of 32%, the IRA charitable rollover will save Susan $3,200 of income tax. After seeing the benefits of this tax-saving and charitable strategy, Susan plans to continue making IRA rollover gifts for the rest of her life.
Richard, age 80, designates his daughter Linda as beneficiary of his IRA. When Richard passes away, Linda is 59 years old and decides to stretch out the distributions from the IRA using the IRS's "Single Life Expectancy Table" to calculate her own RMD. The balance of the IRA in the year that Richard passes away is $500,000. Linda will begin receiving distributions the following year. The distributions will be calculated based on her life expectancy of 25.2 years under the Single Life Table. Linda's first distribution will be equal to $500,000 divided by 25.2, or $19,841. With her federal income tax rate of 32%, Linda will owe $6,349 of tax on the distribution, thereby reducing the distribution to $13,492 after tax. Each year, Linda's distributions will increase. After 26 years, the account will be fully distributed.
Example 3:Bequest of IRA to Charity
Barbara Jones is working with her advisor to put together her estate plan. She wants to use her IRA to leave a legacy gift to her favorite charity after she passes away but also wants to ensure that she provides something for her daughter, Danielle.
Barbara's attorney assists her in creating an unfunded unitrust for her life plus a term of 20 years. Under state law, the unfunded trust is valid but will not be active until Barbara passes away. Barbara fills out a beneficiary designation form for her IRA naming the trustee of the unitrust as beneficiary (e.g., "To Jane Doe as trustee of the Barbara Jones Charitable Remainder Unitrust dated July 4, 2018"). The trust will receive the IRA after Barbara passes away, enabling the trust to make payments to Danielle for a period of 20 years. At the end of that time, the balance of the trust assets will be distributed to the charity.
Example 4:Loan of IRA to Charity
Tina, a surviving spouse, has an IRA currently valued at $2 million. Because her estate is valued at $18 million, which is over the $11.2 million exemption amount, she anticipates that her estate will owe taxes when she passes away. She wants to provide for her children and her favorite charity in her estate plan. She sets up a meeting with her advisor, Dave, to talk about her options.
Dave suggests that Tina designate her favorite charity as beneficiary of her IRA and provide for the children by transferring them assets that will not be subject to income tax, such as her real estate holdings, stock portfolio and liquid assets. He explains that, by doing so, her estate will receive an estate tax deduction and the charity will be able to use the entire value of the IRA because it will not have to pay tax on the amount received. The children will receive the balance of her estate and can avoid the income tax that would have otherwise been due if they inherited the IRA. Tina moves forward with this cost-effective plan and is pleased that she is able to provide for her children and leave a legacy gift to her favorite charity.
Example 5: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.
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.
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.