by Archie M. Richards, Jr., CFP^®
April 1, 2002

Let's say you have a life insurance policy you no longer want. It cost you more in premiums than it's worth, and the policy stands at a loss. Don't cash it in. Exchange it for a variable annuity and use the loss to cut your taxes.

Assume you paid $10,000 in premiums. After commissions and other costs, the policy is worth only $4,000. If you withdraw the $4,000 cash value, you won't be able to use the $6,000 loss for tax purposes. Instead, exchange the life policy for a variable annuity policy and use the loss to reduce your taxable income.

In a variable annuity policy, the insurance company offers you a choice of mutual funds, including stock funds, to make the policy grow. You may "annuitize" the policy at any time. The insurance company would then begin paying out money to you on a regular basis. But most people do not annuitize. They use variable annuity policies as investment vehicles and withdraw the money before annuitizing.

Okay, you exchange your life insurance policy for a variable annuity. The values carry over from one to the other. The variable annuity now has a cost of $10,000, a cash value of $4,000, and a built-in loss of $6,000.

Assume you choose stock mutual funds within the annuity. Over time, these gain by $6,000, increasing the value to $10,000. If you cash in the policy for $10,000, the money comes out tax free, because the built-in loss offsets the $6,000 gain.

You're not required to take out the money when $10,000 is attained. The funds can be left in to continue growing. Upon withdrawal, the net earnings are taxed at the same high tax rates as salary income. But at least some of those earnings are offset by the $6,000 loss.

If you exchange your unwanted life insurance policy for a variable annuity, you'll cut your tax burden. TIAA-CREF and Vanguard both offer excellent variable annuity policies, with low costs and no surrender charges.

Double-indemnity on your life insurance policy doubles the insurance payoff if you're killed by accident. I would avoid double-indemnity. If you have it in your policy, cancel that part of the policy and add the premium savings to your investments.

The manner of your death doesn't affect the amount of money your family needs if you should die prematurely. Decide how much insurance your family needs. Acquire that amount, but forget the double-indemnity. For the insurance company, that's a high-profit item. For you, it's a bum deal.

This column has recommended the allocation of investment money to Vanguard funds of various asset types. Here are the allocations I've recommended. Also shown in parentheses is the record of each fund for the calendar year 2001:

• 30 percent: The Total Stock Market Index Fund (down 10.97 percent in 2001)
• 30 percent: The Total International Stock Market Index Fund (down 20.15 percent)
• 20 percent: The Real Estate Investment Trust Index Fund (up 12.35 percent)
• 20 percent: The Long-Term Corporate Bond Fund (up 9.57 percent)

Had you allocated $10,000 at the end of 2000 to these four funds in the 30-30-20-20 percentages shown, your portfolio would have been worth $9,465 a year later. (This includes Vanguard's extra annual charge of $10 per fund investment under $10,000.)

From $10,000 to $9,465 is a decline of 5.4 percent. It's never fun to lose money. But given the worst bear market in the last two decades, a loss of only 5.4 percent isn't bad at all. Two of the mutual funds were down. But the other two were up. The diversification acted as intended: It made the portfolio less volatile.

Here's an example of an amazing new technology that's going to help drive stock prices higher: The military is developing a robot that flies with tiny flapping wings. It has a two-mile range and projects live color video to the ground in real time.

Get this: The entire device weighs only half an ounce!

In a few more years, when they make those gadgets a little larger, you can have a magic carpet of your very own.