By KELLY GREENE
With interest rates stuck at rock-bottom levels, retirees and soon-to-be retirees are hungry for better returns on their low-risk investments.
Wall Street is rushing to capitalize on this need, rolling out a raft of interest-bearing investments known as "structured notes" that promise higher yields but often carry big risks. Brokers also are hyping dividend stocks, which generate income but can lose value during market storms.
The best places to look for yield and safety, advisers say, are long-term, high-grade bonds and certificates of deposit, which typically offer much better yields than shorter-term bonds and CDs.
But long-term holdings pose a problem for investors in their 70s or 80s who are looking both to generate returns and leave something behind for their heirs. Many economists expect interest rates to start rising and bond prices to start falling in the next few years. By locking up money for the long term, seniors could end up sticking their heirs with investments that fall in value or no longer keep pace with inflation.
A growing number of financial advisers are pointing to a little-known strategy that can help solve this problem: "death puts." Formally known as estate-feature puts, they are available on a handful of high-grade corporate bonds as well as most CDs sold through brokerages.
Death puts guarantee that when the owner of the bond or CD dies, the heirs can redeem it at face value, meaning they get back all the money that originally was invested. The fees usually amount to about 0.125% a year, and come out of the interest payments.
Meantime, buyers collect yields significantly higher than they can get on shorter-term investments. A typical investment-grade 10-year corporate bond currently yields about 3.5%, roughly double the yield of a similar five-year bond. A 10-year CD yields about 2.85%, more than a percentage point better than a five-year CD.
Those yields are far better than can be gotten from longer-term government bonds. A 10-year Treasury note now yields only about 2%, while a German bund yields only about 1.75%.
Some caveats are in order. The biggest risk is that the issuer of the death put defaults on the payments. While the CDs are guaranteed by the Federal Deposit Insurance Corp. up to $250,000, the bonds offer no such backstop. And most of the issuers of bonds with death puts are financial-services companies Bank of America (BAC),
Another risk death puts pose: Some of the bonds and CDs are "callable," meaning the issuer has the right to retire the investments early. The owner would then have to reinvest the money in a lower-rate environment.
Still, those risks are worth taking, say some advisers.
"When you can get a 75-year-old couple 5% instead of 0.7% or 0.9% in a bank, it's pretty attractive," says Larry Rosenthal, president of Rosenthal Wealth Management in Manassas, Va., who recently approached a client with the strategy for his elderly parents.
His proposal, for a $100,000 portfolio of four such bonds, included General Electric (GE)'s
Death puts, first introduced on corporate bonds in the 1990s, have largely flown under the radar. "People don't know they exist," says Jonathan Kurtz, a certified financial planner in Vienna, Va., who told Mr. Rosenthal about them.
But that is changing. Jim Schaberg, a managing director at bond-underwriting firm Incapital, says about $12 billion in notes with death puts have been issued annually in the past three years, and issuance is on pace to rise about 10% in 2012.
Some advisers expect the market to grow more in coming years. "The first wave of the baby boomers need this stuff," says Mr. Rosenthal. "The Fed's not going to raise interest rates for another year or two. The advantage for boomers is to garner this substantially better income for the next decade or so until the banks catch back up again."
Gary Martin, a 75-year-old retiree from military service and the federal government in Sun City Center, Fla., several years ago invested $50,000 in Federal Home Loan Mortgage Corp. bonds with death puts paying 5.35% annually.
So far, he and his wife have used the proceeds to make other investments, such as buying gold, and to take trips, including a tour of New England last fall.
"We go places and have fun, and we don't have to worry," Mr. Martin says. "When rates go up or down, the value remains what we paid for them."
How They Work
Only a handful of companies offer bonds with death puts at any given time. Since the bonds are designed mainly for older retail investors, they're typically underwritten in small chunks and sold through brokerages including Merrill Lynch, Charles Schwab (SCHW)
About 18 companies regularly issue bonds with death puts through Incapital, according to the company. Among them: Dow Chemical (DOW)
Right now, Goldman Sachs is offering a 10-year bond with a 5% coupon. Bank of America, Prudential Financial, Public Service Enterprise Group (PEG),
Why do companies offer death puts on their debt? It gives them a way to access retail investors, who otherwise would be shut out of buying bonds because their orders wouldn't be big enough.
"It's just a little thing that sweetens [the offering] a bit because they need to borrow a lot of money, and they need to figure out how to get that done," says Gary Cotter, a certified financial planner in Sun City Center, Fla.
Be warned: Some bonds must be held for at least six months before the death put could be used. Others have limits on the amount that a bondholder can redeem at one time or on the number of redemptions allowed in a given year. Most companies, including GE Capital and Goldman Sachs, have the six-month restriction, though some stretch it to 12 months, says Mr. Kurtz, the Virginia financial planner.
On the other hand, if you died tomorrow, your heirs probably wouldn't need to use a death put to redeem bonds at par value, because prices are so high that the bonds likely would be worth at least the face value in the open market, says Larry Plaxe, a senior vice president of investments at Wells Fargo (WFC)
Certificates of deposit have lower yields than corporate bonds but offer FDIC protection. There are two types: those issued directly by a bank and those sold through a broker.
Death puts are much more common on brokered CDs, and typically are labeled a "survivor's option." All the CDs sold by Schwab, for instance, offer the feature. Right now, Schwab offers three traditional 10-year CDs, issued by GE Capital, Goldman Sachs and CIT. Each has a 2.85% coupon and a survivor's option, and is FDIC-insured. Interest rates on CDs with death puts typically are competitive with other CDs of the same duration, Mr. Plaxe says.
The main risk with a brokered CD: If you sell it before it matures, you could lose principal, because the products function like bonds. When interest rates go up, their value in the secondary market could fall. In contrast, with a bank-held CD, you would get the principal back but wouldn't collect all of the interest.
Who Should Consider Death Puts?
The people who benefit the most are investors in their 70s and 80s who need to generate income from their savings to pad out a retirement paycheck, says Mr. Cotter, the Florida financial planner.
The investments also make sense for married couples who stand to lose a large portion of their Social Security or pension income when one spouse dies.
Harry Porter, an 85-year-old retired engineer and one of Mr. Cotter's clients, invested in GE Capital bonds with death puts a few years ago. He and his wife use the returns to pay insurance and medical bills.
But if he dies first, his wife could redeem the bonds for the same amount they invested and have more cash available for living expenses. "My company was poor with the pension itself, so you have to start thinking of investments that give you money to live on," he says.
Families receiving the bulk of their inheritance in tax-deferred retirement accounts could redeem such bonds as a source of cash to pay estate expenses while leaving the retirement money untouched, Mr. Rosenthal says.
Death-put bonds might also hold appeal for some younger investors. While they might not have a use for the put itself, the bonds often make monthly payments, rather than the usual quarterly or semiannual payments, says Mr. Schaberg of Incapital.
As for the CDs, if you're counting on living off the interest but might have to cash in a CD early to pay for a big expense, this strategy might not be your best bet. But if you're planning to leave the investment intact as your family's inheritance, it makes sense, advisers say, because the death put removes the risk for your heirs of losing principal if they need to cash in early.
Mr. Plaxe, the Wells Fargo adviser, says he has been using CDs with the survivor's option to help retirees replace maturing CDs that were paying 4% interest, because comparable shorter-term CDs are now paying 2%. He recently found a 3.3% rate on a 20-year CD for an 85-year-old retiree who wanted "the highest rate possible, since he's going to live on the income," says Mr. Plaxe.—Ben Levisohn contributed to this article.—Email: email@example.com