The enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (2001 Tax Act) has many investors confused about estate planning. Because the legislation steadily reduces and eventually temporarily eliminates federal estate taxes, some are under the impression that estate planning is no longer needed. This misunderstanding could prove very costly.

Thanks to the 2001 Tax Act, the amount that may be transferred upon death to a non-spouse without triggering federal estate taxes was $1.5 million in 2005. This exclusion amount has risen to $2 million in 2006 and will rise to $3.5 million in 2009, and an unlimited amount in 2010.

The repeal of federal estate taxes in 2010 is a development that many have been waiting for — but as the law is currently written, it will be short-lived. After 2010, the 2001 Tax Act is scheduled to expire and unless further action is taken, the estate tax will be restored to 2001 levels, with a $1 million exclusion. This “sunset provision” has created a significant amount of uncertainty, which can make investment planning even more challenging.

Because each exemption change can affect your inheritance plans, it’s important to know the timetable and understand the implications. Then, with the help of a financial advisor and a tax professional, you can create an estate plan that is flexible enough to change with the laws. If you have an existing plan that was created before the 2001 Tax Act, it’s important to go back and review your plan with a financial advisor and tax professional to ensure that your assets will be transferred as effectively as possible.

In addition to tax consequences, other important estate-planning components to keep in mind are wills and life insurance.

A carefully drafted will that designates how and to whom your property will be distributed after your death is often the most important aspect of a solid estate plan. Without this document, you give up your right to distribute your wealth as you wish and state law controls the disposition of your assets.

Unfortunately, people often think a “do-it-yourself” will is sufficient. However, estate, probate and tax laws are complicated. In most cases, only a lawyer experienced in these areas knows how to use the legal terminology designed to protect you and your interests.

Once a will is constructed, periodically review it to make sure it’s current. You may need to revise it if you move to a different state, change your life insurance policy, change marital status, inherit or purchase property, or if — as is expected — there is another change in the tax laws.

Life insurance also plays a very important role in estate planning by providing long-term financial security for your family. When evaluating your insurance options, it is important to consider how much life insurance coverage is appropriate, what type of policy will give you the best protection at the best price, and who should own the policy.

Developing a flexible estate plan and closely monitoring any new legislative developments are still important to ensuring that your assets are distributed according to your wishes and with the least possible loss to taxes and fees. For more information on how to effectively transfer your wealth, contact your financial advisor.