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Sunday, May 12, 2024
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Case Studies |
Don't Sell the Bonds
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Case:
Bill and Karen Larson were married for sixty-two years. They had four children who now are adults and on their own. Bill was a careful saver, and a veteran of World War II. He regularly bought Series E savings bonds. Even though the bonds paid an interest rate of three to four percent, when Bill passed away the U.S. Savings Bonds inherited by Karen had a total value of over $3,000,000!
But Bill's last words to Karen were, "Don't sell the bonds."
Karen inherited over $3,000,000 of bonds and rolled over the Series E bonds into Series H bonds. The Series H bonds pay interest semiannually. After listening to Bill's advice, she has no interest in cashing in the bonds. But what should she do? Karen has been informed by her attorney that she should bequeath these savings bonds to her children. In that case, the children will be required to report for tax purposes the accrued interest of over $2,400,000 on the bonds when they are redeemed. The interest on the bonds is called "income in respect of a decedent (IRD)" and, therefore, must be reported by the children who acquire the bonds from the their mother Karen.
Question:
Karen would like her children to benefit from the bonds. She is quite ill at this time and needs to make a decision regarding the disposition of the bonds in the very near future. What is the best strategy to fulfill her objectives?
Solution:
In meeting with her attorney, Karen learns she can change the language in her will to state that the savings bonds will pass to a testamentary charitable remainder trust when she passes away. She is told that by transferring the bonds to a charitable trust upon her death, the trust will report the interest income when it redeems the bonds. Since charitable remainder trusts are tax-exempt, no tax will be due when the bonds are redeemed. In order to make this strategy work, the attorney explains that it is imperative that the bonds be transferred directly to the charitable remainder trust upon her death. If her estate receives the bonds, for example, redeems them and then funds the charitable remainder trust, the estate will be required to report the accrued interest income.
Karen is delighted that she can fund the charitable remainder trust with the bonds and instructs her attorney to draft the appropriate provisions in her will. She chooses to bequeath the Series H bonds to a 6% testamentary charitable remainder trust that will pay income to her children for a period of 20 years. After 20 years, the trust will terminate and the assets will be distributed to her favorite charity. Based upon a total projected yield of 7% on the trust assets, her charity will receive approximately $3.5 million upon the termination of the trust in 20 years. Also, with this investment assumption, the children will receive in excess of $3.9 million in trust distributions over the 20-year period. These results are very appealing to Karen as she is able to "turn" Bill's $600,000 investment in savings bonds into a benefit of over $3 million to both family and to charity.
And she will be honoring Bill's last words, "Don't sell the bonds."
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