By Kyle Zwiren
and Clifford Robison
As your clients' most trusted advisor, we would hope that they would turn to you as life events and other challenges occur. One such life event is a terminal diagnosis, or some other indicator that it's time for the client to get all of her affairs in order.
Your first role is to perform the tasks for which they specifically came to you. As set forth in previous columns under this title, your next role is to guide them through all aspects of the process and making introductions to the professionals who can assist with individual tasks.
In this regard, you can be prepared to steer your client in the right direction as it relates to their investments. You can also generate goodwill with your clients' heirs, and potentially create business opportunities with the next generation.
The problem with investments later in life
A client in her late 70s or beyond is likely to be invested conservatively in cash-equivalents such as CDs and money markets, which may or may not be appropriate based on their specific circumstances. The problem is that those investments don't pay 6% interest rates like they did back in 1999. The bottom line is that cash-equivalents cannot keep pace with inflation.
Elderly individuals tend to focus on conservative investments because they need their money to be safe and liquid. They cannot take on substantial market risk because they may need the cash soon.
One potential solution: Finding income for elderly clients and growth for their heirs
Some corporate bonds contain a little-known survivor's option known as the estate put feature (for more detail on the Estate Put Feature, please see our white paper, at https://www.financial arch.com/the-estate-feature/). By way of background (please bear with me, or feel free to skip ahead a couple paragraphs), corporate bonds are debt instruments issued by corporations who need funding. They differ from stocks in that bondholders are not considered equity owners of the company, and bondholders will usually receive interest payments while they hold the bond.
Bonds can be purchased directly from the corporation, but more often are purchased in the marketplace. They can be bought at par (face value), or at a premium or discount. If purchased at a discount, the bond's current yield (CY), yield to maturity (YTM), and yield to call (YTC) would be greater than par. See the diagram below for a visual analysis.
Corporate bonds with an estate put feature could potentially generate attractive growth for a client, and at times it can be seen as a relatively safe investment. That's not to say there isn't some risk. For example, the biggest risk is that the issuer of the estate put defaults on the payments. That's why it's important to look at the bond's rating. Investors who do not need current cash flows would locate such a bond that is selling at a discount. The bond would pay out an interest payment during the client's life. When the client passes away, the bond's contract would allow the client's heirs to sell the bond back to the corporation at face value. Please keep in mind there could be limitations such as a threshold that issuers will take back in a given year, a possible per-estate limit, and potentially a minimum holding period before the option can be used. As a result, it is important to review a prospectus or offering circular prior to investing.
Here are some actual numbers of such a bond issued by General Electric as of May 22, 2019. Bonds traditionally have a face amount of $1,000. This particular GE bond was selling at a discount of $931.14 and paid 4.705% interest.
So, if someone buys a bond at $931.14 and they passed away one year later, they would have received $47.05 in interest payments and then $1,000 based on the estate put feature. That's a total return of $115.91 or 11.52%.
The estate put feature can benefit your clients
We recently worked with a fiduciary representative for an elderly client. The representative knew his client had a life expectancy of 1-3 years so we suggested commercial bonds with the estate put feature as an option. The client ended up passing away 18 months later, and generated a better return for herself than she otherwise would have if her money was sitting in cash. Then, her grandchildren were pleased when they received the bond's par value in their inheritance, along with the stepped-up basis (see IRC Section 1014). This was a win-win-win for the fiduciary, his client, and her grandchildren. We felt pretty good about it, too.
We presented this product feature at a Financial Architects Lunch and Learn to a room of mostly estate planning attorneys and some CPAs. Many of the professionals in the room had not previously heard of the estate put feature on commercial bonds. And that's not to say they should have; this is an obscure and underutilized opportunity in the marketplace. My colleagues and I wonder why there hasn't been more publicity for this feature, but we're more interested in helping people take advantage of it.
Going back to the attorneys we hosted at our Lunch and Learn. Our intention was not to teach them the intricacies of these investment opportunities. Rather, we wanted to support them in their efforts to become their clients' most trusted advisor, and to develop relationships with the next generation of clients. Because all of our clients will remember when we're looking out for their best interests.
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Attorney Kyle Zwiren works with Financial Architects Inc., an independently-owned company located in Farmington Hills. Zwiren and his team serve attorneys and other professionals to help them design financial plans in line with their goals and based on optimal efficiency. He practiced law prior to becoming a Financial Architect and left the practice to follow his passion. To talk to Zwiren about other topics featured in The Economic Blueprint, email him at kzwiren@financialarch.com or call him at 248-482-3622.
Clifford Robison is a registered representative of and offers securities through The O.N. Equity Sales Company, Member FINRA/ SIPC. Investment Advisory services offered through O.N. Investment Management Company and FAI Advisors, Inc. Financial Architects, Inc. and FAI Advisors, Inc. are not subsidiaries or affiliates of The O.N. Equity Sales Company or O.N. Investment Management Company.
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Ratings are opinions and not recommendations to purchase, hold or sell securities, and they do not address the market value of securities or their suitability for investment purposes. Ratings should not be relied on as investment advice.
The information discussed is educational in nature and is not and should not be construed to be investment advice.
Any fixed income security sold or redeemed prior to maturity may be subject to loss.
In general the bond market is volatile, and fixed income securities carry interest rate risk. Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. No investment strategy can guarantee success.
High-yield/non-investment grade bonds involve greater price volatility and risk of default than investment-grade bonds.
Published: Fri, Feb 28, 2020
