Ever since the tax cut bill of 2001 was enacted, financial advisors who have done any work in estate planning have had their eye on 2010. That is the year in which the features of EGTRRA (the Economic Growth and Tax Relief Reconciliation Act of 2001) are scheduled to “sunset.” Until new law replaces EGTRRA, figuring out the best way to protect client assets and minimize the potential tax bite on heirs will remain dicey: As things stand, the amount excluded from federal estate tax continues to rise, to $3.5 million in 2009. Then estate tax disappears completely in 2010, only to come back in 2011 at the 2001 rate — a $1 million exclusion and a top rate of 55 percent (see table).

It's easy to see why some financial advisors would steer clear of this quagmire. But those who do may be depriving clients of an important service and cutting themselves off from future income. The betting in Washington is that full repeal will not occur — repeated attempts to move such a bill through the Senate have repeatedly failed — but that a compromise will be reached that would keep the 2008 exclusion and perhaps cut the top rate. This means that estate planning will remain a very important need for wealthy clients.

What's more, the wealth-preservation tactics that were inspired by pre-2001 law, which taxed any estate assets over $675,000, have evolved into standard financial-planning tools. Peter Radloff, vice president of advanced markets with Jackson National Life Insurance Company in Denver, says that “over the past few years, there has been about a 30 percent increase in the number of reps using trusts and funding of some of these trusts with life insurance.”

Taking the Offense

There are several good reasons why advisors should know how to use trusts and insurance. Even without a big federal tax bite, many states levy estate or death taxes, and a number of states — desperate for revenue — have raised them in recent years. They could become even more desperate because their revenues have often been linked to the federal estate tax take and, if an exclusion compromise is on the high side, they'll want to make up for any loss by raising taxes even more.

Thomas Henske, senior partner with Lenox Advisors in New York, sees the need for trusts and insurance even if there is no estate-tax exposure, because the combination provides good protection from probate, a costly court process used in settling estates after an owner's death.

Another reason for having trusts and insurance is that they help in getting the most out of an estate. Estates tend to be illiquid. They include slow sellers like real estate, businesses and collectibles, and if there are no trusts and insurance to pay taxes on the inherited assets, there is often pressure by the heirs to sell the holdings — fast. If so, they're likely to get less from a quick sale than if they had they waited for the best offer.

It can work out even worse if the dumped asset is a successful business; there are significant tax advantages if the heirs keep the company going another 10 years before selling it. Moreover, they can then spread out any tax payments over 14 years if the business is 35 percent of the estate.

The last reason for being aggressive about drawing up trusts and taking out insurance is that insurance may not be available later. Your clients are getting older and becoming less insurable, and the cost to insure them is rising as they age. So at the time life insurance is finally “wanted” and needed the most, it may be unattainable or unaffordable.

The Advisor's Advantage

Your role is providing the right life insurance for the right amount, held in the right way. That usually means some type of permanent insurance with a guaranteed death benefit that is held in a trust.

The most important step to take is to have a “heart-to-heart” talk with your clients about their goals, wants, assets and concerns. Few people waltz up to a rep and say, “Hey, I think I need to set up and fund an irreversible life insurance trust [ILIT].” Rather, they count on you to open the discussion.

Sure some clients say, “I don't want to make my kids rich.” But they also don't usually intend to leave their heirs with liquidity and tax problems that could be quite substantial by the time they die.

If you are working with a couple in their late 50s or early 60s, Henske says, “Remember their assets, returning 7.2 percent, should double every 10 years.” So, if one of them lives for another 30 years, a $1 million estate could be worth $8 million. There's a good chance one of them could make it, too. Sixty-two percent of couples will have one survivor after three decades, according to LIMRA International, an insurance research organization.

Both Radloff and Henske recommend funding future estate tax and liquidity needs with permanent life insurance — generally whole life insurance. These insurance policies can be placed in an ILIT, so they bypass the estate probate process and federal estate taxes entirely.

However, if your clients don't see the need for committing a large chunk of money to pay premiums on whole life insurance, because “there aren't gonna be estate taxes when I die,” consider convertible, guaranteed level term life insurance. This gives your clients “locked-in” insurability in case their health deteriorates and ensures estate liquidity — a factor overlooked by people who feel that they won't owe estate taxes.

Advisors also need to walk clients through the costs. For a high-net-worth client to do comprehensive estate planning the legal fees can easily run $6,000 to $10,000 initially, according to Henske, on top of any life insurance premiums. Still, while that's not small change, you need to stress the expense is affordable for someone with their income and assets — and well worth it.

Estate planning can buy your clients and their heirs peace of mind, privacy, liquidity and asset preservation at a reasonable cost. So what are you waiting for?

The Evolving

Estate-Tax Breaks
Year Exclusion Amount Highest Estate Tax Rate
2006 $2,000,000 46%
2007 $2,000,000 45
2008 $2,000,000 45
2009 $3,500,000 45
2010 Full Repeal*
2011 $1,000,000 55
* Unless a new legislation is enacted, the tax disappears for one year, then returns in 2011.
Main Types of Trusts Used in Estate Planning (Not All-Inclusive)*
Type of Trust/Benefits Simplicity Cost Tax Benefits Basic Features
Totten or Payable on Death (POD) Very simple Little or no cost None • Skips probate for certain assets such as funds and checking accounts
• Privacy
Living revocable — Credit Shelter, A/B, etc. Very simple to highly complex Under $1,000-to tens of thousands of dollars. Usually done at same time as will. Preserves the 2nd unified credit amount for a couple, ensures assets pass to intended heirs. • Skips probate for included assets
• Privacy
• Used with blended families, spendthrift heirs, property in other states, etc.
Charitable Trusts — CRT, CRAT, CRUT, etc. Fairly to very complex Can be quite low if intended charity covers part of cost. Otherwise several thousand dollars or more. Current tax deduction; additional deductions from estate taxes. • Skips probate for included assets
• Privacy
• Create/leave a legacy
• Fund trust or replace assets with life insurance
Living Irrevocable — Insurance trust is common example Fairly simple Moderate cost (under $2,000 or so) Allows life insurance to be held outside estate; ensures liquidity. • Skips probate for included assets
• Privacy
• Liquidity
* Note these are only basic guides.
It is essential to direct clients to get qualified legal and tax advice. The above is not legal or tax advice.