Bequests of Savings Bonds to Charitable Remainder Trusts

Clients sometimes are reluctant to cash in U.S. savings bonds (bonds that have reached full maturity) because they don’t want to pay tax on the accrued interest.  The bonds, sometimes worth six figures or more, end up creating income in respect of a decedent for the estate or beneficiaries.

Philanthropic clients might wish to establish a testamentary unitrust and specify that the trust will be funded with the savings bonds.  Tax results?  Elimination of income taxes on the savings bonds when they are redeemed by the trustee of the unitrust, which is tax exempt.  The interest on the bonds will be passed through to the trust beneficiaries as part of their annual unitrust payments, under the four-tier system, and taxed as ordinary income.  But there is no depletion of the trust corpus from tax.  Furthermore, the donor’s estate is entitled to an estate tax charitable deduction. 
Two words of caution: 

• If a client’s estate is subject to federal estate taxes, beneficiaries apparently will not be able to take advantage of a tax break usually available to recipients of IRD assets. The IRS has ruled unfavorably in a case involving retirement accounts where the account passes at death to a charitable remainder trust.  Heirs normally receive an income tax deduction for estate taxes that were owed on an IRA or other retirement account (IRC §691(c)(1)(A)).  Now, says the IRS, if the IRA passes to a CRT, the deduction will belong to the trust, not passed through to the income beneficiaries.  The result is to convert part of the trust’s income (IRD) to tax-free corpus – which the income beneficiaries may be unlikely ever to access, due to the four-tier system of CRT taxation (PLR 9901023, 10-8-98).  The same reasoning would also seem to apply to savings bonds bequeathed to a CRT. 


• Savings bonds can be transferred to a CRT only via will or revocable living trust, not by beneficiary designations on the bonds themselves.  Furthermore, existing co-owner or beneficiary designations generally would need to be removed (by having the bonds reissued), to enable the bonds to pass under the client’s will or revocable living trust.

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