Look at alternatives to suggested annuity

Q: I'm in my early 70s and have a financial adviser who is proposing that I purchase a large life insurance policy, transfer my IRA to an immediate annuity and use the annuity payments to pay for the life insurance policy.

The adviser also is suggesting that I set up a trust to be the beneficiary of the life insurance policy to avoid estate taxes. It sounds good, but the premiums are pretty high -- about $22,000 a year -- and I would need to convert my entire IRA to an annuity in order to generate that large of a payment.

I know that when I die, the annuity payments will stop, but the life insurance death benefit is almost three times the value of my IRA.

My main concern is the irrevocability of this plan. Once I purchase the immediate annuity, I can't change my mind, and if I change my mind about the life insurance policy, I will lose all the money I have paid in premiums.

Is this a good way to provide my children a large tax-free inheritance?

A:You are wise to think twice about proceeding with changes to your financial situation that are irrevocable.

The plan suggested might make sense in your situation, but there are some alternatives that might be more financially attractive and could provide the same results.

Making a trust beneficiary of a life insurance policy will not help reduce estate taxes; the trust must also own the policy. If you own the policy, the death benefit will be included in your estate, regardless of the beneficiary designation.

Proceeds from life insurance are tax-free to beneficiaries, but if you also want the proceeds to be excluded as an asset of your estate, the policy cannot be owned by you.

If estate-tax savings is a concern, meet with a lawyer to discuss setting up an irrevocable life insurance trust as the owner before you purchase the life insurance. The federal estate tax exclusion for 2007 and 2008 is $2 million.

You might be able to get a higher death benefit for the same premium or a lower premium with the same death benefit by purchasing a policy from an insurance company that has no sales charge or surrender fee. In addition to lower costs, if you change your mind and cancel the policy, the cash-value surrender will be much higher than commission-sold insurance. Contact a company that sells such policies for a comparison quote. One option is Ameritas Direct, www.ameritasdirect.com or (800) 555-4655.

Transferring your IRA to an immediate annuity might be appropriate if you like the idea of a guaranteed payment and assume you will have an above-average life expectancy. If you decide to pursue an annuity, I suggest that you compare lower-cost annuities to the ones you were probably quoted.

Charles Schwab, T.D. Ameritrade, Vanguard, Fidelity and other no- load mutual fund companies and discount brokerage firms offer immediate annuities.

The annuity payments made from your IRA will be subject to income tax, so make sure the after-tax amount will cover your life insurance premiums if this is your only source of funds for this purchase.

As an alternative to the annuity, consider guaranteed investments such as certificates of deposit.

If you are comfortable investing on your own, I suggest you purchase CDs in your IRA.

You could invest five years of the life insurance premium in short-term CDs (6 months to 1 year), and as they mature, pay the premium and invest the remaining funds. Place the remaining amount into a five-year CD. This strategy should provide the same income stream as the annuity for 18 years, assuming the average rate of return is 5 percent. The annuity will guarantee that you won't outlive your money, but if you use the laddered CD approach, you might get a much higher rate of return than the annuity, and any money left in your IRA will be distributed to your designated beneficiaries.