BondsOnline Advisor
July 2005
by Stephen Taub

How Death Puts Can Keep Principal Alive

If you are in line to inherit a portfolio of bonds, you have two choices: Hold the issues to maturity or sell them in the secondary market, take whatever price you receive and pay a big fat commission. Right?

Not necessarily. There is a third choice. In some cases, you can "put" back the bonds to the issuer at "par" and get back the original principal investment. And there is no commission charged either.

This is called a Survivor's Option or, as it's called in the trading community, Death Put.

Although not widely known, this is a popular estate planning feature in the relatively new market for bonds issued to individual, or retail, investors - from LaSalle with its Direct Access Notes (DANs) Merrill Lynch with its CoreNotes, and InCapital through its Internotes program.

"Most retail note programs feature a survivor's option" says Nancy Ludwig, vice president, DANs product manager, LaSalle Broker Dealer Services Division, referring to the Death Puts.  "They allow for a lot of flexibility; individual investors like the fact that, in the event of their death, their estate can sell the notes back to the issuer at par."

"They are as popular as they have ever been," adds Jim Schaberg, managing director with InCapital.

Retail bonds are typically offered weekly and in $1,000 increments. The price and coupon remain constant throughout the week, allowing individual investors extra time to make their decision. New issues are always offered at par.

To exercise the Survivor's Option, most of the bonds must be held for at least one year from the original date of issue.  If the beneficial owner passes away prior to the one-year holding period, the deceased's estate must hold the notes for the remaining time period before the Survivor's Option may be exercised.

Keep in mind that the beneficiaries must exercise the survivor's option before they take possession of the bonds, as the bonds must be held in the deceased holder's account for the survivor's option to be applicable.  The prospectus/offering circular contains all the details. 
 
Sounds like a win-win deal? Yes, in most cases.

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If the bonds are trading below par when you inherit them, you instantly recover the lost principal if you "put" back the bonds. This is a big bonus in a rising interest rate environment, when the price of bonds tends to fall. "If rates go up, many (of the bonds) will trade at a discount to par," making it especially appealing to redeem these bonds at par, or 100, Ludwig says.

In most cases, holders of bonds with Survivor's Options have a year after the original owner dies to make the decision whether to put back the bonds.

Why do issuers offer this feature? Essentially, to attract the retail market, which likes the comfort of knowing their principal is not being put at risk.

But, are investors giving up a little income to obtain this feature? Schaberg says the major New York wirehouses have told him they feel the market value of the Death Puts is 10 to 15 basis points. "They would rather see a higher coupon," he concedes.

LaSalle's DANs program  takes the mystery out of buying bonds and appeals to investors for whom it is important to know they won't lose money on the bonds when they hold them to maturity.

There are some limitations to Survivor's Options. For example, individuals who want to put back bonds are typically limited to $200,000 per social security number per issuer in a calendar year.

In addition, most issuers limit the total amount that could be "put back" to 1 percent of the outstanding par value at the end of the most recent calendar year.

And what if the bonds are trading at a premium? Currently, many of the retail notes have surged to premiums above par as spreads have tightened. So, Schaberg says it makes more sense not to put back the bonds, and instead sell them in the secondary market and find the best bid.

Adds Rob Little, managing director, Debt Capital Markets at Merrill Lynch: "As baby boomers age and diversify their portfolios out of equities, there should be a lot of demand for alternative sources of fixed income." And a desire to protect the principal for their heirs.

These issuers currently offer Survivor's Option bonds:

Survivor’s Option or Death Put Bonds (as of June 2005)

Issuer	Survivor’s Option Eligibility	Annual Put Limits (Greater of)	Individual Put Limits (annual)
Federal Home Loan Mortgage Corp	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
Caterpillar Power Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
UPS Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
TVA Electronotes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
Lasalle Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
Marshall & Illsley Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
John Hancock Signature Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
SLM Education Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
AGF income Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
ILFC Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
IBM Notes	12 mos. After issuance date	$1MM of 1% of outstanding aggregate	$200,000
Bank of America Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Daimler Chrysler Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Boeing Capital Corp Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Dow Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
PHH Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
CIT Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Merrill Lynch CoreNotes	Owned by decedant/estate 6 mos. prior to request	$5MM of 5% of outstanding aggregate	$500,000
Gillette CoreNotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Bank of New York CoreNotes	Owned by decedant/estate 6 mos. prior to request	$5MM of 5% of outstanding aggregate	$500,000
General Mills CoreNotes	Owned by decedant/estate 6 mos. prior to request	$5MM of 5% of outstanding aggregate	$500,000
GE Capital Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Household Internotes (issued after 5/29/02)	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Sears Roebuck Accpt Corp Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Wells Fargo & Co CoreNotes	Owned by decedant/estate 6 mos. prior to request	$5MM of 5% of outstanding aggregate	$500,000
Principal Life CoreNotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Protective Life Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Prudential Internotes	Owned by decedant/estate 6 mos. prior to request	$2MM of 2% of outstanding aggregate	$250,000
Ford Motor Credit Co.	Owned by the decedant for 6 mos.	$2MM of 2% of outstanding aggregate	$250,000
Diageo Notes	Owned by the decedant for 12 months	$2MM of 2% of outstanding aggregate	$250,000
GMAC Smart Notes	Anytime after date of issuance	$1MM of 1% of outstanding aggregate	$200,000

Survivor's Option or Death Put Bonds (as of June 2005)