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Lock In Gain on Your Bonds with a Gift Annuity Before Interest Rates Rise

When most people consider securities, stocks come to mind. Stocks represent an equity position in the issuing corporation—whether large or small. The stockholder’s investment fortune is tied to the performance of the corporations. However, bonds that are debt instruments are not as familiar as stocks, even though they trade as actively as stocks and fluctuate in value on a daily basis—sometimes quite sharply. The principal factor that affects the movement in the price of bonds is interest rates. As interest rates head up, the value of bonds trends down; as interest rates go down, the value of bonds trends higher.

Many individual bond owners view bonds as investments that generate cash flow. This is particularly true of many older individuals who are retired and rely on the interest that bonds pay for their living expenses. And whenever one of their bonds matures, it is simply rolled over and reinvested in a similar bond.

The Risk of Bonds in a Recovering Market

As most of you know, the U.S. government and the Federal Reserve in their efforts to deal with the current economic crisis have driven interest rates to historic lows. The impact of their efforts is that the value of bonds has risen, in some cases quite dramatically.

For example, a $100,000 30-year U.S. government bond yielding more than 9% in 1989 would now be worth more than $150,000. Reason: The yield to maturity on a comparable 10-year bond is only about 2.8%.

A person who is fortunate enough to own such a bond will continue to collect the promised interest of $9,170 a year for the next 10 years, at which time the government will pay back the $100,000 face value of the bond that it borrowed 30 years ago.

So what happens to the $50,000 profit appreciation that the bond has today? It simply evaporates over time and is completely gone when the bond matures. Another downside is that if interest rates start going up—which they will probably do as the economy improves—the value of the bond will go down. So the current profit is at risk from both passing time and higher interest rates.

As this example illustrates, bondholders may feel as though they are sitting on a time bomb with three fuses:

1. The bond may be subject to provisions that allow the bond issuer to call in the bond at face value.
2. Even if the bond is not called, it will be worth nothing more than its face value if held until maturity.
3. Rising interest rates will signal the melting away of investment appreciation.

If the investor in our example wishes to lock in the profit in the bond, then the bond must be sold, thus generating capital gain of $50,000 and a 15% tax of $7,500. The question then is where to reinvest the proceeds. For the older, retired person who is averse to risk, stocks are not a viable option. Fixed-income instruments currently have a paltry yield, so that is not a very good option either—albeit a safer one. For these reasons, appreciated bonds can be an excellent choice to fund charitable gifts.

A Safe, Viable Option: A Charitable Gift Annuity

A charitable gift annuity with our institution is tailor-made for this situation.

Example: Robert S, 80, owns a 30-year U.S. Treasury bond that he purchased in 1989. He paid $100,000 for the bond originally, and it pays him $9,170 a year. Because of the drop in interest rate to below 3%, the current value of the bond has risen to more than $155,000. But if Robert holds on to the bond until maturity, the government will pay him only $100,000, the original face value of the bond. The appreciation of more than $55,000 will vanish.

Robert is delighted to learn that by contributing the bond to us in exchange for a gift annuity he is able to capture the significant appreciation in the value of the bond, generate guaranteed income at a high rate of return, and also make a meaningful charitable gift.

Results: Robert receives guaranteed annual annuity payments of $11,045; nearly 50% of the annual payment is tax-free; and about 25% of the payment is taxed at the favorable 15% capital-gain tax rate for the duration of his life expectancy. In addition, he receives a charitable deduction of almost $75,000, saving him more than $26,000 in his 35% tax bracket.

Call our office today to request a complimentary personalized illustration of how a gift annuity may benefit you.