In a recent retirement discussion with a colleague, he mentioned his retired parents having a lot of their assets in investment grade corporate bonds. I challenged whether this is a good idea, asking: “aren’t they worried about what rising interest rates will do to the value of those bonds?” His counter was that it wasn’t a concern because when they die, the estate can redeem the bonds at their full par value.
This feature in a corporate bond got me thinking about what other reset options are available at – or triggered by – death. In other words, what financial vehicles offer benefits that are specifically activated when a death occurs? This is a legitimate concern because an individual’s death often generates a need for spouses, families and businesses to rearrange their finances. A spouse suddenly needs survivor income, a family’s estate unexpectedly requires liquidity, and a deceased’s business abruptly experiences a cash crunch.
There are more financial vehicles to help with this challenge than you may realize. Often they have arcane names and are sometimes optional features lost in the maze of choices associated with financial instruments. Let’s look at a few of these features and, perhaps most importantly, the benefits.
This is the concept my colleague was referring to. A death put (also called a survivor option) is an optional redemption feature on a corporate bond allowing the estate of the deceased to put (sell) the bond back to the issuer at par value in the event of the owner’s death. This can prove useful in retirement income planning because a highly rated corporate bond will generate a secure stream of income. The concern, however, is that the bond’s market value could sink when interest rates rise. If the owner of the bond dies during a high interest rate market, the beneficiary may suffer a significant loss of principal should the bond be sold. Investing ina bond with a death put assures that the beneficiary can still receive the bond’s par value at the owner’s death.
POD bank accounts
A payable-on-death (POD) account is an individual bank account with a beneficial feature at the owner’s death – it avoids probate. The account owner designates one or more beneficiaries to receive the proceeds upon the owner’s death. Because the proceeds pass directly to the beneficiaries designated by the account owner, the proceeds are not subject to the delays and expenses associated with probate. Further, the beneficiaries of the account have no rights in the account during the account owner’s life, and the owner may change the beneficiaries at any time.
Immediate annuity refund feature
An immediate life annuity provides an income that the annuitant can’t outlive. For an agreed upon amount of money, an insurer will pay an income based on the individual life being measured. The challenge is that a loved one may suffer financially if that individual dies prematurely. Say a husband invests $100,000 in an immediate annuity based on his life, and he dies a year later. The wife suffers a financial loss; the principal is gone, as is the stream of income. For this reason, insurers can price in a benefit in this type of annuity that will mitigate such a loss. Typically called a refund feature, the insurer will pay an income for the annuitant’s life, but guarantee that the total amount paid out to the beneficiary will not be less than the initial investment. The beneficiary will at least get back the initial investment. This benefit is priced into the annuity quote, and offers liquidity and more assurances for survivors.
Deferred annuity death benefits
People often think of annuities as the flip side of life insurance. Annuities are insurance against living too long, while life insurance covers dying too soon. What happens, however, when a policy owner dies before an annuity has started paying out an income? A deferred annuity is an annuity that builds up value currently, with the intention of paying out income in the future. Sometimes these annuities are invested in separate accounts chosen by the owner. The challenge is that if the owner dies when the market is down, the annuity may be worth less than the initial investment, and the beneficiary will suffer a financial loss. To mitigate this loss, insurers often offer a death benefit feature for their deferred annuities. For example, the annuity may provide that if an owner dies when the value of the contract is less than its initial investment, the beneficiary will still receive no less than what was invested. Some annuity contracts will even include, for a price, a step-up feature, where the death benefit rises to a new value at designated points in time.
No lapse guarantees
When one thinks of a “death benefit,” the first financial contract typically considered is life insurance. The whole point of a life insurance policy is to provide liquidity that is triggered by the death of the insured. Modern day policies have a plethora of riders, options and features focused on the death benefit aspect of life insurance. Consider, however, the issues involved with making sure the life insurance policy itself is in force at the insured’s death. The risk may be that, because of market conditions, an ongoing premium is insufficient to continue the policy in force. In other words, the policy is at risk of lapsing. Some life insurance policies offer a feature that covers this contingency. A no lapse guarantee, as the name implies, states that as long as the insured pays an agreed upon premium, the policy will not lapse, even if the policy has run out of cash value. This guarantee can be for a certain number of years, up to a particular age, or for the life of the insured.
No one wants to die, but also no one wants a beneficiary to suffer financially because of a death. The examples above are just a sampling of possible options. As you review your financial portfolio with your advisor, consider financial products, features and benefits that can protect your heirs and beneficiaries. There are contractual tools available that can, at death, trigger reset options, provide liquidity and guarantee fulfilment.