Bonds with Estate Puts

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

These are typical questions expected when estate planning. As investors move from one stage of life to the next, their financial goals may 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 an easy transfer of wealth to the next generation. Choosing the best investment opportunities to accomplish each of these goals can be challenging.

Bonds are a popular choice since they are designed to offer predictable cash flows, steady income and a return of face value at maturity. When planning for an eventual transfer of an estate and ensuring heirs will have access to funds, investors often direct their attention to insurance products but should not overlook the features that individual bonds may offer. Since bond prices fluctuate depending on prevailing interest rate levels, investors are cautious that liquidating a bond prior to maturity may mean that proceeds from a sale will be less than the original purchase price. What some investors do not realize is that, under certain circumstances, some bonds may be redeemed at the greater market price or par prior to maturity.

It is hard to predict the timing of 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 prices. However, if rates have increased since a bond's purchase, there may be a market loss thus reducing the estate's value.

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 (CDs), carry an estate preservation 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 holder’s bonds at full face value subject to certain annual limitations. Depending on current market conditions, the beneficiary may choose one of two ways to liquidate the bonds if necessary. If the bonds are trading above par, it is generally 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 preservation 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 preservation 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.

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.

Fixed income securities (or “bonds”) are exposed to various risks including but not limited to credit (risk of default or principal and interest payments), market and liquidity, interest rate, reinvestment, legislative (changes in tax code), and call risks. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices generally rise. Investors should discuss the risks inherent in bonds with their financial advisor.

Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.

Next >