As insurance professionals know, federal estate taxes will recommence on January 1, 2011, ending nearly a decade of confusion regarding their future.

This confusion has made it difficult for planners to assist clients in creating programs to ameliorate these taxes. Since virtually no one knows precisely when a person will die, it has been impossible to come up with a foolproof plan–because of the lack of certainty about estate taxes.

If a client has sufficient personal wealth to be subject to the estate tax, that client will be in good shape if he or she dies in 2010. But should the client survive 2010, planning may be needed to avoid the confiscatory estate taxes that come back with a vengeance in 2011.

The difficulty with estate planning always lies in the inability to predict what tax changes will take place every time Congress meets, plus the inability to predict when a person will die. Regardless, one thing is always certain: Liquidity helps to overcome whatever obstacles that may occur. The easiest and most efficient method for providing this liquidity is life insurance, and planners have recommended its use for estate liquidity for as long as estate taxes have existed.

The need for liquidity arises because of the timing of calculation of estate taxes and their payment.

The Internal Revenue Service is expert at determining the value of estate property at its highest point, particularly illiquid estate property like closely held businesses and real estate. It is not unusual for the IRS to try to value illiquid property as of time of death (or, when permitted, at an alternative date) as though the property is easily salable on the open market. If, in fact, there is a shallow market for such property, a dispute often arises between the IRS and the estate over the actual value to ascribe for purposes of levying the estate taxes.

This lack of accord over the value of estate assets often requires appraisals that can escalate the property value over what the actual value is when a sale takes place.

Moreover, the IRS expects to be paid promptly. This is often difficult when large portions of the estate are illiquid and will take a considerable amount of time to convert to cash. This is exacerbated if the family desires to retain the illiquid asset.

Thus, the need for a source of liquidity while everything gets sorted out.

Life insurance provides for an income tax-free source of cash to help to pay estate taxes. Although life policies that are owned by a decedent at time of death are includable in the estate for estate tax purposes, most planners can use methods to avoid such ownership by the person or persons most likely to die the soonest.

Obviously, the time to figure all this out and to implement the life policies and the trusts and other mechanisms necessary to minimize the estate taxes that will be owed is long before death becomes imminent.

During the years the estate tax was being reduced with an eye to its eventual demise, many in the insurance industry began to believe that life insurance was no longer a necessary element in estate planning. The current confusion about estate taxes clearly demonstrates that this belief was incorrect.

The past decade is when large amounts of life insurance should have been implemented so that it would be available for future liquidity needs as the estate tax gets put back in place. Then, even if the estate tax should somehow eventually be eliminated, the valuable asset of the life policies would still be available to provide liquidity for other purposes even after affording the necessary liquidity for when the estate taxes were in place.

Life insurance, particularly when used in estate planning, is by nature a long-term undertaking. Therefore, it is necessary to look to the potential for inflation’s ravages against the value of fixed policies.

For this reason, the two of us have always recommended products that provide a hedge against inflation. For the past 25 or so years, that has meant variable universal life with some or all of the underlying investments held in equity investments that provide a hedge against inflation. More recently, indexed life policies have provided an equally valuable protection against the inevitable erosion in purchasing power.

In these times of low interest rates and economic crisis, the inevitability of inflation seems even more pronounced and therefore inflation-protected products are more likely to be necessary in the future. Though neither VUL nor index life policies provide perfect protection against inflation, they can be superior to products having inflation built into their fundamental fabric.

Despite Congressional maneuverings on estate taxes, it’s important to manage in such a manner that unnecessary exposure to estate taxes can be avoided.