Q. I am a middle-aged professional. I contribute the maximum amount each year to my 401(k) plan and my non-deductible, traditional IRA. In addition, I have begun a Couch Potato portfolio. Since this is a taxable account, I would like to substitute series I Savings Bonds for the Total Bond Index Fund.

I plan to invest yearly so rebalancing can be accomplished by adding additional money. After the 5-year requisite holding time, if some of the bonds are far below current rates, they could be sold and new ones purchased. I plan to contribute for about 15 more years before having to use this to possibly supplement my retirement income.   I would appreciate your analysis of this idea.

---S.D., by e-mail

  

A. That's a great idea. The I Savings Bonds are about as safe as bonds can get--- they're a U.S. government obligation and the principal is indexed to the rate of inflation. The big unknown for these bonds is how big (or small) a premium over the rate of inflation these bonds will pay at different times of purchase.

The highest premium over inflation--- the "real" return--- on these bonds was for bonds issued between May and October 2000. It was 3.60 percent plus the rate of inflation. Anyone who bought I Savings Bonds during that six month period will get that 3.60 percent yield plus inflation for the 30-year life of the bond.

That was an absolute slam-dunk. According to Ibbotson Associates, the real return on long-term government bonds (1926 through 2002) was only 2.5 percent. As a consequence, I Savings Bonds buyers in that period could expect a better than historic long-term return.

You can see the history for I Savings Bonds at www.savingsbond.com/ichart.html Since then, however, the premium over inflation has been declining, reaching a low of 1.10 percent for the current six-month period (May through October). With the government running a $500 billion deficit, I think it's reasonable to expect the premium will increase in the future.   "Reasonable," however, is not to be confused with "inevitable."

Your contribution to a non-deductible IRA indicates either great saving zeal, a high income, or both. Since the tax-deferred return on your investment will be taxed at ordinary income rates when you make withdrawals I suggest that you stop making those contributions. Instead, add the money to your taxable account. The returns will be currently taxed at 15 percent and you'll be building the supply of money you can access without creating what the Internal Revenue Service calls "a taxable event."

Any day you can avoid a taxable event is likely to be a good one.

  

Q. My wife and I were just blessed with a second child. While I am a traditional investor for retirement, children's college, etc. my insurance agent proposed an "investment" for my new child. He suggested that I purchase a Variable Universal Life Insurance policy on my newborn. He stated that the insured (my child) will be rated with the lowest premium rate and the premiums can be invested in mutual funds and grow tax-free. He said that when the insured gets older, say 30, he could get a loan against the balance of the policy. The loan will be advanced tax-free, and need not be repaid. The loan value will be deducted from the death benefit. In other words, the VUL policy will allow tax-free growth in mutual funds, and allow my son to withdraw funds from the policy tax-free through the guise of a loan.

Is this possible, and what is the catch? I do understand that the fees in the VUL are somewhat high, at approximately 2.1 percent, but the tax benefit might outweigh the fees. What do you think?

---R.S., Dallas (by e-mail)

  

A. There is a reason insurance companies own the largest buildings in every city in America. You've just encountered it. Your insurance agent is proposing that you establish a lifetime trust fund for the insurance company, giving them a significant cut of every dime you invest for your child. It commits you, or your son, to making a lifetime of payments to keep the policy in force. It guarantees the insurance company a lifetime of rising life insurance premiums and investment management fees.

Without even considering the life insurance cost, the 2.1 percent annual management fees would take about 21 percent of the long-term return on common stocks. That's higher than the current 15 percent tax rate on common stock dividends and capital gains.

As an alternative, you can simply buy shares in a Total Market Index fund. It will be highly tax efficient and any taxes will likely be paid at no higher than a 15 percent rate. Since you can buy such funds with annual expense ratios of less than 0.3 percent a year, there is absolutely no reason to seek the tax deferral of a Variable Life Policy for a newborn.

I'm not saying that life insurance itself is a bad idea--- I believe most Americans need more life insurance, not less. What I'm saying is that this use of the product does more for an insurance company and its agents than for the policy owner.