Finance Charity-Owned Life Insurance with your IRA

In a Private Letter Ruling issued late in 2007, the IRS approved a clever technique to leverage a gift  to your favorite charity using your IRA and life insurance.  Developed by Douglas Delaney, a CPA and attorney in South Carolina, the "CHIRA®"  works something like this:

  1.  The donor rolls over funds from a regular IRA to a self-directed IRA. The donor and the charity apply for the life insurance.
  2. An loan (with market rate interest due) is made to the selected charity from the donor's new IRA. The loan is secured by a new life insurance policy purchased by the charity on the life of the donor.  The charity signs a promissory note payable to the IRA.
  3. The charity assigns to the IRA the portion of the death benefit equal to the outstanding loan from the IRA.

Here's an example for the CHIRA® website:

A 74 year old donor decides to loan $1 million from her IRA to her favorite charity. The charity uses $30,000 each year to purchase a $1 million life policy on her life. The death benefit is used to fully repay the loan. Today, the charity will have $970,000 to allocate to their charitable purposes as well as a prudent interest and premium reserve. Whether it is cash to sustain their budget for a few years, or to put shovels in the ground two years early, the CHIRA® plan provides immediate capital without income tax to the donor.

The IRS concluded that (1) this is not a prohibited transaction within the meaning of Section 4975 of the Internal Revenue Code which would terminate the IRA under Section 408(a)(3), and (2) is not a prohibited investment in life insurance by an IRA under Section 408(a)(3) of the Code.  What this means is that this technique results in no taxable income to the donor.

However, this a complex, multi-step technique, and everything must be done correctly in order to achieve the intended consequences.  If you decide that a CHIRA® makes sense for you, make sure that you consult with tax counsel to ensure that you will face no adverse tax consequences.

Click "Continue Reading" for the full text of PLR 200741016.

This is in response to a letter dated May 22, 2004, as supplemented by correspondence dated February 17, 2005, June 2, 2005, August 30, 2005, January 9, 2006, June 21, 2007, June 26, 2007, June 28, 2007, and July 3, 2007, submitted on your behalf by your authorized representative in which you request a ruling concerning the tax treatment under section 408 of the Internal Revenue Code (the "Code") of a proposed loan from your individual retirement arrangement (IRA) to an organization which you represent is exempt from taxation under section 501(c)(3) of the Code.

The following facts and representations have been submitted under penalties of perjury in support of your ruling request.

On May 27, * * *, Taxpayer A established a self-directed rollover individual retirement arrangement, IRA X, with Company P. Documentation submitted with this request shows that Taxpayer A established IRA X with a deposit in the amount of Amount D with a transfer of funds from an IRA he maintains with Company M.

The IRA X plan document provides, among other things, that the IRA Depositor may designate a representative under the custodial agreement through whom Company P is authorized to accept investment instructions for the depositor's account; that the IRA Depositor may direct Company P to invest the IRA assets into any lawful investment that is acceptable to Company P; and that the IRA Depositor is responsible for determining the suitability, nature risk, etc. of the investment and understands that he or she may not invest IRA assets in an investment that would constitute a prohibited transaction within the meaning of Code section 4975.

Taxpayer A proposes to direct an investment of his IRA X assets (Amount D) in the form of a loan to Church B. It has been represented that Church B is a tax-exempt religious organization as described in Code section 501(c)(3). Taxpayer A is neither a board member nor an employee of Church B. Taxpayer A has no control, ownership or financial interest in Church B. Taxpayer A represents that he does not currently intend to, either presently or at some future date, take a charitable deduction in conjunction with the loan contemplated herein.

In exchange for the loan, IRA X will receive a twenty-year promissory note. The promissory note provides, in part, that Church B promises to pay Amount D to the order of Company P, IRA Custodian f/b/o Taxpayer A, with interest at the rate of five percent per annum until paid. Interest payments will be made by Church B on an annual basis. The promissory note also provides that a final, balloon payment in the amount of Amount D shall be paid in full upon the earlier of the end of the term of the promissory note (twenty years) or within one hundred twenty (120) days, or a reasonable period after the date of death of Taxpayer A. Repayment of the promissory note will be to the order of an independent IRA custodian and will go to IRA X. The promissory note allows for prepayment without penalty. The promissory note further states that Church B grants Company P a continuing security interest in the insurance policy collaterally assigned within a reasonable period relative to the execution of this obligation and that Church B shall not be entitled to convey, borrow upon or otherwise transfer any rights associated with said policy without the express written consent of Taxpayer A.

You represent that the purpose of this security agreement within the promissory note is to provide additional certainty for Taxpayer A that the ownership of the insurance policy, will, from the date of purchase until the date of death, continue to qualify as an insurable interest under state law. Taxpayer A, pursuant to the terms of the security agreement within the promissory note will directly require Church B to seek written approval of Taxpayer A for transactions related to transfer of ownership, borrowing and other major changes that may impact the policy.

It is further represented that the contractual relationship evidenced by the promissory note is between Company P and Church B and establishes the legal obligation to pay. You also state that commercial reasonability requires proper collateralization of the promissory note and that this collateralization, in this case, is evidenced by two agreements: (1) the collateral assignment form agreement between the company that will issue the life insurance policy, Taxpayer A, Church B and Company P, and (2) the security agreement within the body of the promissory note executed between Church B and Company P.

You represent that the intent to have two collateral agreements is to provide ample protection, outside of the contractual terms set forth within the insurance company's collateral assignment, that there will be a continuing "insurable interest". You state that Taxpayer A is the most appropriate party to protect this interest. It is further represented that while written approval is required to convey, borrow upon or otherwise transfer any rights associated with said policy, Taxpayer A is never directly entitled to the death benefits under the policy and that Company P is the obligor under the promissory note and it will receive any payments of funds. You note, that Taxpayer A, however, is the insured and should have the ultimate decision with respect to their individual insurable interests.

The promissory note will be secured by collateral assignment of a permanent life insurance policy which will insure Taxpayer A's life. The life insurance policy will be purchased and owned by Church B and provide a death benefit in the amount of Amount D. Church B will be the beneficiary of the life insurance policy. Church B will have all rights of ownership and benefit from any increasing death benefit that may be generated by the life insurance policy. Neither Taxpayer A nor IRA X will have the right to surrender, convert, pledge, cancel or sell the life insurance policy. Neither Taxpayer A nor IRA X will have the right to change or amend the beneficiary designation of the life insurance policy. Church B will not be entitled to convey, borrow upon or otherwise transfer any rights associated with the life insurance policy during the period of collateral assignment without the express written consent of Taxpayer A.

It is represented that IRA X is not the contract owner of the life insurance policy nor is IRA X the beneficiary thereof. IRA X, through Company P, does not have the ability to surrender, convert or sell the life insurance policy. Further, IRA X does not possess equity features in the form of either (1) the ability to surrender, convert, pledge, sell, cancel, or transfer the policy, (2) the ability to amend the beneficiary designation nor (3) any continuing beneficial interest in the increasing death benefit that may occur during the ownership of the life insurance policy.

It is further represented that the IRA X investment is a collateralized loan bearing interest with adequate collateral to guarantee repayment of the principal amount of the loan outstanding at Taxpayer A's death to IRA X. It is represented that IRA X is a secured creditor of Church B and not an investor in or contractual owner of the life insurance policy so that the IRA X proceeds are not invested in life insurance contracts as that term is used in section 408(a)(3) of the Code.

In a letter dated August 30, 2005, it was represented that the required minimum distribution for Taxpayer A will commence at approximately five percent of the IRA X account balance and will increase each year. Taxpayer A projects that the annual five percent interest payments from Church B on the loan will be utilized, in part, to satisfy his required minimum distributions under Code section 401(a)(9). You further represent that the balance of Taxpayer A's required minimum distributions will be satisfied by distributions from other IRAs held by Taxpayer A.

Based on the aforementioned facts and representations, you have requested the following rulings:

1. The above described transaction is not a prohibited transaction within the meaning of section 4975 of the Code such that the IRA would cease to be an IRA under section 408(e)(2) of the Code.

2. The above described transaction is not a prohibited investment in insurance within the meaning of section 408(a)(3) of the Code such that the IRA would cease to be an IRA under section 408(a)(3).

Section 408(a) of the Code generally provides that an IRA means a trust created or organized for the exclusive benefit of an individual or his beneficiaries.

Section 408(a)(3) of the Code provides that no part of an IRA trust may be invested in life insurance contracts.

Section 408(e)(2)(A) of the Code provides, in part, that if an individual for whose benefit an IRA is established, or his beneficiary, engages in a transaction prohibited by section 4975 of the Code in connection with the IRA at any time during the individual's taxable year, the account ceases to be an IRA as of the first day of such taxable year. In any case in which any account ceases to be an IRA as of the first day of any taxable year, the account will be treated as having distributed all of the assets of such account.

Section 4975(c)(1)(B) of the Code provides that any direct or indirect lending of money or other extension of credit between a plan and a disqualified person is a prohibited transaction.

Section 4975(e)(1) of the Code provides, in part, that the term "plan" includes an IRA described in section 408.

Section 4975(e)(2) of the Code provides, in part, that a "disqualified person" means a person who is --

(A) a fiduciary;

(B) a person providing services to the plan;

(C) an employer any of whose employees are covered by the plan;

(D) an employee organization any of whose members are covered by the plan;

(E) an owner, direct or indirect, of 50 percent or more of --

(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,

(ii) the capital interest or the profits interest of a partnership, or

(iii) the beneficial interest of a trust or unincorporated enterprise, which is an employer or employee organization described in subparagraph (C) or (D);

(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);

(G) a corporation, partnership or trust or estate of which (or in which) 50 percent or more of --

(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,

(ii) the beneficial interest of such trust or estate, is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);

(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more in yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or

(I) a 10 percent or more (in capital or profits) partner or joint venturer of a person described in subparagraph (C), (D), (E) or (G).

Section 1.408-2(b)(3) of the Regulations provides that no part of an IRA trust may be invested in life insurance contracts.

Section 20.2042-1(c) of the Regulations provides, in part, that "incidents of ownership" includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy.

With respect to the first ruling request, Church B is not related to IRA X in a manner that would come within the definition of a disqualified person as described in Code section 4975(e)(2)(A) -- (I). Conversely, Taxpayer A is not a board member or an employee of Church B nor does Taxpayer A control, own or have a financial interest in Church B.

Accordingly, with respect to your first ruling request, we conclude that the above described transaction is not a prohibited transaction within the meaning of section 4975 of the Code such that IRA X would cease to be an IRA under section 408(e)(2) of the Code.

With respect to the second ruling request, Church B will purchase and own the life insurance policy, as well as have all rights of ownership and benefit from any increasing death benefit that may be generated. Church B will pay the premiums on the life insurance policy. You represent that IRA X is not the contract owner of the life insurance policy nor is IRA X the beneficiary of the policy. In the event of Taxpayer A's death, only the promissory note will be repaid to IRA X. IRA X will not receive or benefit from any death benefit that may be generated from the life insurance policy.

Accordingly, we conclude that the above described transaction is not a prohibited investment in insurance within the meaning of section 408(a)(3) of the Code such that the IRA would cease to be an IRA under section 408(a)(3).

This letter ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling does not express an opinion as to whether IRA X, exclusive of the language contained in the IRS Model Custodial Agreement (Form 5303-A) meets the requirements for qualification under Code section 408(a). This ruling does not express an opinion as to whether Company P is qualified to serve as a custodian of IRAs as stated on page 2 of Company P's IRA Custodial Agreement that was submitted with this ruling request. This ruling does not express an opinion as to validity of the terms of the promissory note or the terms of the life insurance policy that Taxpayer A proposes to use in connection with this transaction nor does it express an opinion as to whether the requirements of Code section 408(d) were satisfied with respect to the establishment of IRA X with Company P. Further, this ruling does not express an opinion as to the method in which Taxpayer A proposes to receive his required minimum distributions from IRA X satisfies the requirements of Code section 401(a)(9).

No opinion is expressed as to the tax treatment of the transactions described herein under the provisions of any other section of either the Code or the Income Tax Regulations, which may be applicable thereto that are within the jurisdiction of other offices of the Internal Revenue Service.

A copy of this letter has been sent to your authorized representative in accordance with a power of attorney on file in this office.

Sincerely yours,

Joyce E. Floyd, Manager
Employee Plans Technical Group 2

Trackbacks (0) Links to blogs that reference this article Trackback URL
http://www.ncestateplanningblog.com/admin/trackback/103136
Comments (1) Read through and enter the discussion with the form at the end
Doug Delaney - January 7, 2009 2:16 PM

How Does CHIRA® Compare to CHARITABLE GIFT ANNUITIES (CGA)?


1. AGREEMENT. Both involve a lifetime irrevocable transfer of assets to charity pursuant to a contractual agreement. With CGA, the contract is a promise to pay a fixed amount to the donor over their lifetime made by the charity. With CHIRA®, the contract is a secured promissory note signed by the charity in favor of the donor’s retirement account. For more information on CGA, see www.acga-web.org . For more information on CHIRA®, see www.chirausa.com .


2. TRANSFER OF VALUE. With CGA, the donor transfers after-tax assets, such as appreciated stock, to charity and receives the charity’s unsecured promise to pay. This promise to pay is called an annuity. The present value of the annuity is less than the amount transferred. The excess amount is deductible by the donor for income tax purposes. By law, charity must receive an immediate minimum of 10% benefit based on actuarial values. With CHIRA®, the donor makes a gift of their insurable interest, or ability to obtain insurance, to charity. In many cases, the donor would not have otherwise purchased insurance. Assuming the donor already has sufficient insurance, this transfer does not “cost” the donor. As a result, there is no charitable deduction for the transfer of an insurable interest to the charity. The donor through their IRA loans funds to the charity. The charity reserves a portion of the funds to pay the insurance (which is used to repay the loan) and to pay future interest. The excess funds are used for charitable purposes. The loan is not deductible to donor, but it does not trigger income tax. It is tax neutral and a way for donor’s to redirect funds in a safe and easy manner for charitable purposes.


3. AGREEMENT DURATION. In exchange for the transfer of value, the CGA and CHIRA® differ in the period over which the funds are repaid. With CGA, the annuity payment can be over one lifetime or two. The CGA repays the donor with funds originally donated. With CHIRA®, loan principal is fully repaid upon the death of the insured. Interest is paid annually to the retirement account from the charity. The charity benefits from the loan during the donor’s life.


4. ILLIQUIDITY. With both plans, the donor agrees to “tie up” property in return for future cash payments. With CGA, the donor ties up after-tax assets. After-tax assets are typically used for consumption needs. The donor has exchanges the ability to consume the totality of asset transferred for the charities agreement to pay the agreed upon annual amount. A CGA requires the donor to become illiquid with respect to a substantial amount of principal. With CHIRA®, the donor ties up pre-tax assets. The loan principal is typically repaid at death. Pre-tax assets are typically used for long term investment because of the built-in income tax. Therefore, the illiquidity presented by the CHIRA® plan often has less impact on the donor’s day to day consumption needs.

5. PRINCIPAL REPAYMENT. Charitable payments are comprised of principal, or return of capital, and an interest component. With CGA, a portion of principal is returned with each payment. Depending upon how long the donor lives, it is possible that all of the principal may not be fully repaid with CGA (see “Mortality Risk” below). With CHIRA®, principal does not have to be repaid until death. Supported by an in-force insurance policy, principal is guarantee to be completely repaid to donor’s IRA regardless of how long the donor lives.


6. INTEREST RATES and INDUSTRY REGULATION. Both CGA and CHIRA® are based on applicable federal rates. CGA are generally regulated at the state level through departments of insurance with guidance from the American Counsel of Gift Annuities CHIRA® plan loans are regulated by state law through departments of insurance and securities. The policies provided in the course of the CHIRA® plan have strict underwriting and compliance thresholds to determine charitable intent.


7. SECURED OR UNSECURED. With CGA, the annuity promise to pay is an unsecured, general obligation of the charity. As a general obligation of the charity, CGA could be one of the last obligations to be satisfied by the charity if it dissolves and might not enjoy full repayment. CHIRA® notes are secured transactions backed by a life insurance policy on the donor collaterally assigned to the retirement account. In the event of dissolution, the life insurance policy may or may be of significant value. Dissolving charities have several options on how to repay these secured creditors. In the event that the policy is transferred to the retirement account, there would be a taxable event. Many donors would be satisfied with receiving taxable value as opposed to pennies on the dollar. Because donors are a lower priority creditor with CGA than with CHIRA®, the CHIRA® plan provides more lifetime protection to the donor than does CGA.


8. MORTALITY RISK. Both plans include a mortality risk that may favor charity. However, the mortality risk for the donor’s family with CGA can be substantial and detrimental, if the donor dies early. With CGA, the annuity payments stop upon death. The initial charitable gift deduction for CGA is based on the actuarial life expectancy of the donor. If the donor does not live to life expectancy, the donor may actually transfer more to charity than they initially expected (i.e.., the minimum 10%). In such a case, the deduction allowed would be significantly lower than the value actually transferred to charity. The donor, in this case, would have transferred much more to charity than that claimed by deduction.

For example, a 70 year old donor transfers $100 in stock and receives a CGA with a present value of $90. The donor receives a tax deduction of $10. After a few years, the donor dies after receiving $20 in annuity payments. The donor was promised $90 but only received $20. The donor’s early death had a mortality cost of $70. The charity benefited from this $70, but there is no income tax deduction allowed for this transfer in wealth.

With CHIRA®, the donor’s IRA is fully repaid. There is no mortality risk to the donor’s family regardless of how long the donor lives. If the donor dies early, the charity may release valuable reserves to assist in their charitable purpose. The CGA can work detriment to the donor upon early death. The CHIRA® does not.

9. CHARITABLE BENEFIT. For both plans, the immediate cash benefit to charity is measured by the difference in value between the asset transferred and the present value of the future carrying costs, such as reserves for mortality risk, insurance cost and interest component. For CGA, each dollar transferred must result in no less than 10 cents in immediate benefit to charity after consideration of proper reserves. For CHIRA®, each dollar transferred may also result in a charitable benefit in excess of 20 cents, especially with healthier donors.

10. PRE-TAX AND AFTER-TAX ASSETS. There is a significant difference between the use of pre-tax and after-tax assets transferred to charity in the planning. Pre-tax retirement assets are often deferred as long as possible. After-tax assets are used for consumption needs such as mortgage payments, groceries and travel. CGA require a transfer of after-tax assets and therefore compete with the donor’s consumption needs. CHIRA® involves pre-tax assets and does not compete with a donor’s consumption needs. As demonstrated above, the tax deduction provided through CGA is often much less than the value transferred to charity. The CHIRA® enables the charity to benefit while ensuring the return of the capital upon death.

CHIRA® provides a legitimate alternative to Charitable Gift Annuities, especially in these times where donors are struggling to meet family obligations and charitable goals.


Post A Comment / Question Use this form to add a comment to this entry.







Remember personal info?
Send To A Friend Use this form to send this entry to a friend via email.