Bonds with Estate Puts

  • Will your investments provide enough income to live on in retirement?
  • Will you be able to live comfortably while still preserving your estate?
  • Will interest rates be higher in the future than they are currently?
  • Will there be a smooth transfer of your assets from one generation to another?

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 because they are designed to offer predictable cash flows, steady income and a return of face value at maturity. 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 the greater of market price or 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 is reliant upon current market values.

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 an inherited 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 certain annual limitations. 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.

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.

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.

Investing always involves risk and you may incur a profit or loss. No investment strategy can guarantee success.

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