These questions are some of the driving forces behind estate planning. As investors move from one stage of life to the next, their financial goals change. For many investors, the immediate concern is to generate enough current income to live on without having to considerably deplete the principal value of their assets. Others are anxious to preserve their estates so that they will provide for their spouses and on death ensure easy transfer of wealth to the next generation. Choosing the best investment alternatives to accomplish each of these goals can be challenging.
When selecting investments to offset monthly living expenses, bonds are a popular choice since they are designed to offer predictable cash flows and a return of principal at maturity, subject to the issuers’ credit worthiness. There are a number of successful fixed income investment strategies that help address possible loss of future purchasing power and minimize interest rate risk. However, when it comes to planning for an eventual transfer of an estate and ensuring heirs will have access to funds, investors often direct their attention to insurance products rather than bonds. Since bond prices fluctuate depending on prevailing interest rate levels, investors are cautious of the fact that liquidating a bond prior to maturity may mean that proceeds from a sale will be less than the original purchase price, or par value. However, what some investors do not realize is that, under certain circumstances, some bonds may be redeemed at par prior to maturity.
It is hard to predict when wealth will become an inheritance. Consequently, the eventual conversion of an estate to cash for distribution may require a sale of invested assets. In the case of a bond portfolio, the distribution of the estate may not coincide with the bonds’ maturities and liquidity of assets may become an issue. When bonds are sold, the proceeds will reflect the current market environment, which depends on the present level of interest rates, among other factors.
If rates have decreased since the original purchase, then the next buyer will be willing to pay a premium for the higher coupon rate and the value of the estate may actually increase. However, if rates have increased since the original purchase, then the new buyer will demand a discount for the loss of income and the proceeds of the estate may be less than expected.
In order to limit the impact of changing interest rates on a fixed income portfolio, certain types of government- sponsored enterprise securities and corporate bonds, as well as brokered FDIC-insured Certificates of Deposit, carry an estate protection feature.
This feature commonly referred to as a Survivor’s Option or Death Put, allows an estate representative or executor of the beneficiary to submit a request for redemption of the deceased bondholder’s bonds at full face value subject to limitations and the issuer’s creditworthiness. However, depending on current market conditions, the beneficiary may choose one of two ways to liquidate the bonds. If the bonds are trading above par, it may be beneficial to sell them in the secondary market. If the market price is at a discount, then the estate may choose to redeem bonds with the issuer and receive par. Both choices include payment of any accrued interest.
Investors who do not need current cash flows should consider purchasing estate protection bonds offered at a discount from par value. This will allow the estate to build in capital gain potential if the bondholder passes away prior to the maturity date.
Many estate protection bonds feature a call provision, which allows an issuer, at its discretion, to redeem, or call, bonds prior to the stated maturity date. If a call occurs, it may affect the yield. Hence, investors must analyze returns under different redemption scenarios prior to investing.
Each bond issue may have specific redemption limitations and a prospectus or offering circular must be reviewed carefully prior to investing. Limitations may include minimum holding periods (typically six months to one year or longer), a maximum amount per decedent, per bond issuer, per year (typically $250,000 or less) and a maximum aggregate amount accepted for redemption by each issuer annually. When an annual limit is reached, an issuer may defer redemptions until subsequent years. Investors should know that instant liquidity may not be available when choosing to exercise the death put. This may impact the length of time during which an estate remains open.
When a brokered CD features a Survivor’s Option, an estate representative or executor may submit a request for redemption of the CD to the issuer in the event of the beneficial holder’s death. In general, the tenders should be submitted within a reasonable amount of time, but in some cases may be limited to 180 days after the beneficial holder’s death. Terms and conditions are fully described in the CD’s disclosure document.
If bonds are held in joint tenancy with right of survivorship and one of the owners passes away, many issuers will honor the survivor's option for the additional protection and liquidity of the estate. The joint tenancy may be set up between couples, parent and child, or as deemed best in each individual situation. Tenants in common and other ownership capacities may have less than the entire position qualified. The estate protection feature is not available for certain types of accounts, such as accounts that are titled to an entity rather than an individual. As the guidelines differ between issuers, it is imperative to review a prospectus prior to purchase.
In light of the market environment, bonds with an estate protection feature should be taken into serious consideration for retirement and estate planning. In a well-diversified portfolio, these investments may add liquidity, flexibility in disbursing estate assets and preservation of the value of the estate.*
Fixed income investments make it convenient to match current and future income needs with needs for estate preservation. To further discuss how your financial plan can benefit from bonds with an estate protection feature; please contact your Raymond James financial advisor.
*Diversification does not ensure a profit or protect against a loss.
While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of Raymond James & Associates we are not qualified to render advice on tax or legal matters.
Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Past performance is not indicative of future results. Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.