With the 2008 presidential election fast approaching, the state of the estate tax remains unresolved. Current law, the Economic Growth and Tax Relief Reconciliation Act of 2001, provides for an increase of the estate tax exemption from our current level of $2 million to $3.5 million in 2009 with a temporary repeal in 2010. Come 2011, however, EGTRRA sunsets and the estate tax exemption amount drops to $1 million, with a tax rate of 55%.

Congress previously focused on a total repeal of the estate tax after 2009. With the 2007 change in Congressional leadership, complete repeal may be out of the equation as the focus shifts to reform. With no crystal ball, it is impossible to predict what reform will take place. What is clear, however, is that the estate tax uncertainty continues and it is important that advisors be equipped to deal with this uncertainty.

Is an estate plan necessary?

For most clients, estate planning is necessary to delineate family relationships, distribute property and to minimize taxation at death. Clients, however, cannot know exactly when they will die and what the tax system will look like at their death. The most prudent thing to do is to plan one’s estate with flexibility under the current tax regime, to allow one’s estate plan to adapt to any future tax law changes.

By waiting, clients may lose out on the opportunity to make years of annual exclusion gifts and to use techniques that may reduce or freeze the size of their estates. During a “wait-and-see” period, their health may also decline, foreclosing the opportunity to purchase life insurance at affordable premiums. Consequently, if death occurs in a year when there is an estate tax, their estate may be faced with a large estate tax bill without the sufficient liquidity to pay those taxes.

Many clients are concerned about being “stuck” in an estate plan if there is a possibility that their estate may not owe estate taxes. It is therefore important that clients continue to plan. This is especially true for ultra wealthy clients for whom any tax reform (short of complete estate tax repeal) would not relieve their estate of estate taxes.

The adaptable ILIT

Making an estate plan as flexible as possible can ease client concerns about planning during this uncertain time. By creating a properly structured irrevocable life insurance trust to be the owner and beneficiary of a life insurance policy, clients can remove the asset from their taxable estate.

Because the ILIT is irrevocable–meaning it cannot be changed or accessed–it is important to build flexibility into the vehicle so as to allow for new options and alternatives should estate tax laws change. Here are 4 techniques that can help an ILIT adapt to possible changes in the tax laws:

1. Draft the ILIT as a Spousal Lifetime Access Trust (SLAT). Similar to the traditional ILIT, a SLAT is an irrevocable trust designed to keep the life insurance death benefit proceeds outside of a couple’s taxable estate. The SLAT provides a married couple with indirect access to the life insurance policy’s cash value through trust distributions to a non-grantor spouse during his or her lifetime. SLAT provisions allow the trustee to make income and gift tax-free distributions to the non-grantor spouse. If the trustee is an independent third-party, distributions may be completely within the trustee’s discretion.

If the federal estate tax is repealed or reformed, the couple may still have access to the cash value of the life insurance policy that was purchased for estate liquidity, and use it to supplement retirement income or other family needs. With a properly structured and funded SLAT, the life insurance death benefit proceeds paid at the death of the insured(s) should pass to the beneficiaries of the SLAT estate tax-free and income tax-free.

2.Allow the trustee to make ILIT loans. Drafting an ILIT with terms that allow the trustee to lend money to the insured can also provide indirect access to a life insurance policy’s cash value for family needs or retirement while excluding the life insurance death benefit proceeds from the insured’s taxable estate. For wealthy clients who are not married and, therefore, cannot use a SLAT, drafting an ILIT that grants discretion to the trustee to lend money to the grantor/insured may provide the flexibility desired. The grantor/insured should provide collateral or security for such loans and pay interest to the trust to minimize scrutiny by the IRS.

Despite this indirect access, the life insurance death benefit proceeds should still pass to the trust beneficiaries free from estate and income taxes.

3. Give the trustee the right to terminate the trust. The power-holder of this right can effectively unwind the trust in the event of estate tax repeal or substantial reform and distribute all the trust assets to the beneficiaries of the trust.

4.Give the trustee the ability to make distributions to trust beneficiaries for education and other purposes. If the life insurance is no longer needed for estate tax purposes, the trustee may take income tax-free withdrawals and loans from the life insurance policy’s cash value and make distributions to the beneficiaries. A life insurance policy’s cash value grows tax-deferred, so the life insurance policy could serve as a good alternative source of funds for the beneficiaries’ education or other purposes.

Wealthy clients need to plan their estates rather than wait for the estate tax uncertainty to be resolved. By choosing techniques that add flexibility to their ILITs, wealthy clients can obtain the protection needed today with the ability to adapt their estate plans to future changes in tax laws.

Aimee Kwain, J.D., is a consultant in the Advanced Designs Unit at Pacific Life Insurance Co., Newport Beach, Calif. You can e-mail her at .