Okay, let’s break down teh advice regarding the life insurance loan versus margin loan, and then the clarification on Qualified Charitable Distributions (QCDs).
Life Insurance Loan vs. Margin Loan – Analysis
You are absolutely right to question which loan makes more sense.Based solely on the interest rates provided (2% vs. 8.75%), the life insurance loan is substantially cheaper. Your reasoning is sound: a low-interest loan secured by an asset you already own,with the potential for the loan to be covered by the death benefit,is very attractive.
However, the article does point out some important pitfalls, and these are crucial to consider:
Policy Lapse: This is the biggest risk. If the loan plus accrued interest grows larger than the cash value of your policy, the policy could lapse. This means you lose the insurance coverage and the cash value. Furthermore, a lapsed policy can have tax implications (see below).
Reduced Death Benefit: Even if the policy doesn’t lapse, the outstanding loan balance (plus interest) will be deducted from the death benefit paid to your beneficiaries. This is what the article means by “leaving a beneficiary short of funds.”
Tax Implications (if policy lapses): If the policy lapses and the loan amount exceeds the cost basis of the policy (the premiums you’ve paid), the excess could be considered taxable income. Impact on Cash Value Growth: the cash value in your life insurance policy grows over time. Taking a loan reduces the amount available to grow, potentially slowing down the accumulation of future cash value.
To make a fully informed decision, you need to:
- Understand your policy Details: Carefully review your life insurance policy documents. What are the specific terms of the loan? What is the maximum loan amount you can take? What happens if the loan balance exceeds the cash value?
- Calculate the Impact: Project how the loan and interest will affect your policy’s cash value over time. Consider different repayment scenarios.
- Consider Your Repayment Plan: You mention regular cash flow. Having a solid plan to repay the loan is essential to avoid the pitfalls.
- Consult a Financial advisor: The article correctly suggests talking to a fee-only financial planner. They can assess your overall financial situation and provide personalized advice.
Qualified Charitable Distributions (QCDs) – Clarification
The follow-up letter and Liz Weston’s response clarify a very important point about QCDs. You are correct to point out the apparent contradiction between what some mutual fund companies say and Weston’s initial answer.
Here’s the key takeaway:
Direct Transfer is Crucial: To qualify as a QCD, the money must go directly from your IRA to the charity. It cannot pass through your hands.
Debit Card/Bank Account = Taxable Distribution: If you have the money distributed to you (even temporarily, via your bank account), and then use a debit card to donate, it’s no longer a QCD. It’s considered a regular IRA distribution, and you’ll owe income tax on it.
Checks are Okay: Checks drawn directly from your IRA (either by you or the custodian) and sent to the charity are acceptable QCDs.
Security Concerns with Checks: Weston acknowledges the risk of mail theft and check fraud and provides good advice on mitigating those risks (gel pens, post office, monitoring).
In essence, the convenience of using a debit card for online donations is not worth losing the tax benefits of a QCD. You need to find charities that accept direct transfers from IRAs or stick to checks.
Overall:
The advice in the article is generally sound, but it’s important to dig deeper and do your own due diligence. Don’t rely solely on the stated interest rates; consider the potential risks and long-term implications of each option. And always seek professional financial advice tailored to your specific circumstances.