Those of us in the over-50 crowd remember "flower bonds." These were low coupon U.S. Treasury bonds sold at a discount (less than 100 cents on the dollar) and redeemable at par value (full maturity value or 100 cents on the dollar) to pay the estate tax. Their value "bloomed" at the death of the owner. There are no more flower bonds, but the private sector has come up with something similar.
Death put bonds, or more genteelly named "survivor's option bonds," are now available from some bond issuers. A put is an option granting the holder the right to sell. A "death put" means the heirs can require the issuer to buy the bond back at face value if the owner dies. Depending on what you paid for the death put bond and the current interest rate environment, your estate could make a nice profit by exercising the death put option. Unlike flower bonds, the proceeds can be used for any purposes; they are not limited to paying estate taxes.
The bonds come from established underwriters, and investment-grade companies issue them. Some are insured. Experts say you pay very little extra for the death put — perhaps 10 to 15 basis points. For a very small premium, your heirs are protected against rising interest rates. In addition to rising interest rates eroding the secondary market value of a bond, an issuing company's gloomy financial outlook could drive down the market value dramatically.
Some of the death puts have restrictions. The owner may need to hold the bonds for a minimum period of time, say six months or a year. Some issuers may refuse the put feature for bonds purchased on the date of death. The amount of bonds that may be put back may be limited by a dollar amount on a first-come, first-served basis.
Typically, an issuer will limit the total amount that could be "put back" to one percent of the outstanding par value at the end of the most recent calendar year. Other issuers may limit the amount that can be "put" back on a per investor basis. For example, an issuer may limit exercise of the death puts to $200,000 per Social Security number in a calendar year.
It may be important to keep the bonds in the deceased holder's account for the survivor's option to be applicable. If so, the beneficiaries must exercise the survivor's option before they take possession of the bonds. In most cases, the heirs have a year after the owner dies to make the decision whether to put back the bonds. For the details of all of these restrictions and conditions, reading the prospectus is key.
The face value of the bonds may be considered the value at death, which gives a step up in basis. That means there may be more estate or inheritance tax, but then the good news is that there is no capital gain when putting the bonds.
The ability to put the bonds back to the issuer is a valuable tax option for heirs who otherwise have to hold them to maturity or sell them in the secondary market for whatever price they can get.
Of course, if the bonds are trading above par, it makes more sense not to exercise the "survivor's option," or death put, and just sell them on the secondary market to the highest bidder.
Issuers offer this feature to attract the retail market. Older bond purchasers like the security of knowing that their principal is not being put at risk — or rather, that they are not putting their heirs' principal at risk.
E-mail: Patti@spencerlawfirm.com