(FORTUNE Magazine) – What's new in estate planning? Glad you asked. Congress is talking about lifting the number of tax-free dollars you can give away during your lifetime from $600,000 to $1 million, the tax bite on family businesses may be in for an adjustment, and there could be more. It was all reviewed recently when four of the country's top estate planners--one from Texas, three from New York--dropped by for a discussion of these and other critical issues. Our panel included S. Stacy Eastland, a partner in Houston's Baker & Botts; Elizabeth L. Mathieu, president and CEO of Neuberger & Berman Trust Co.; Carlyn S. McCaffrey, a partner in Weil Gotshal & Manges; and Arthur D. Sederbaum, a partner in Patterson Belknap Webb & Tyler.

The papers are filled with stories about people fighting over their inheritances. What's the reason for all the sound and fury?

SEDERBAUM: Often poor estate planning.

MCCAFFREY: I'm not sure it's that simple. If you leave a business to kids who don't like each other, they'll fight no matter how good the planning.

EASTLAND: The unfortunate thing about most family fights--whether it's a battle over a will, a divorce, or whatever--is that the litigants usually aren't focused on what they're getting. What drives them crazy is what the other guys are getting.

MATHIEU: The really unfortunate thing is how much of their inheritance often winds up with Uncle Sam.

That's a good place to start. What's the biggest estate planning mistake people are making these days?

SEDERBAUM: Forgetting that assets in a retirement plan like a 401(k) were never taxed. When they are finally distributed, the beneficiary has to pay an income tax. In addition, an estate tax will be imposed on whatever remains in the retirement plan at death, and a third tax--which is generally called the success tax--could take another 15% bite out of the excess retirement accumulation. That tax may be repealed in the current tax bill, but it's not gone yet.

MATHIEU: People also forget they have to make decisions before they turn 702 about how they are going to take distributions from their retirement plans, and who has rights to those assets after their death. If they don't, the bill for income, estate, and success taxes could reach 85%. The total tax bill can actually go to 125%, but Uncle Sam is only authorized to take 100% of your assets. The government wants us to save for retirement, but not too much.

MCCAFFREY: The purpose of retirement plans wasn't to enable us to accumulate money that we'd leave to our children. They were established so we'd be able to take care of ourselves when we retire, and Uncle Sam feels he's done his bit if he takes it all back after we die.

Can't creative estate planning get around the problem?

MCCAFFREY: You can delay and defer taxes on assets that have accumulated in a retirement plan, but you can't completely escape them. On the other hand, there are some things you can do to ease the pain. For example, if you need money when you're in retirement and have the option of selling Microsoft stock you own outright or taking cash out of your IRA, the smart thing would be to dip into the IRA. At your death, your Microsoft and your IRA will be subject to the same estate tax, but there will be a step up in the cost basis of the stock. That is, your estate won't pay income tax on the appreciation in the stock, but it will have to pay income tax on the IRA.

The boom in the stock market and its impact on 401(k) plans have created a lot of new millionaires. If someone wanted to get serious about estate planning, what's the first step?

MATHIEU: Deciding whether your priority is retirement income or estate planning, and what you want to accomplish in each.

SEDERBAUM: Then you'd need a balance sheet. You don't have to get into the nitty-gritty of how many shares of XYZ you own, but you need to separate assets into broad categories--real estate, marketable securities, cash, life insurance, retirement plans--and divide them into classes that show whether they're owned by husband, wife, or jointly. Then you would figure out what the income and cash-flow situation would be if one of the two were to die. And then you'd want to focus on the individual or institutional executors, trustees, and guardians you'd want to include in your estate planning process.

EASTLAND: In thinking about the fiduciary appointments, it's important to recognize that the person you'd want as a guardian for your minor children would almost certainly be different from the person you would want as an executor or trustee. And then the key question is, How would you distribute your property if you didn't have taxes to worry about?

Are you suggesting that the goal is not to avoid taxes?

EASTLAND: That would be the tail wagging the dog. Once you figure out where you want the properties to go, then you go to work and try to save taxes.

SEDERBAUM: A plan is worth nothing if it saves gobs of estate tax dollars and yet doesn't do what you want it to accomplish.

Who should be part of the estate planning team?

MCCAFFREY: This may not be a popular thing to say, but if we're talking about someone who has a house, some insurance, a salary, and an uncomplicated tax return, you don't need to bring in layers of professionals. A lawyer can prepare all the estate planning documents.

MATHIEU: I'd disagree. Most people have mutual funds, an IRA, and stocks they own outright. Even with the greatest legal documents and the best planning in the world, you can end up with a mess if the money is poorly managed or the investment manager has no clue how to respond to the retirement income and estate planning that's been done.

MCCAFFREY: To the extent the person has investments that need to be managed, I agree. But I draw a distinction between the things we do as estate planners and the things others do as financial planners. Investment planning is important, but it's not necessarily part of the estate planning process, which involves wills and trusts and that sort of thing.

Let's get back to goals. I want to make sure my wife has enough to live comfortably and my grandchildren go to college. Where should I begin?

EASTLAND: Right at the start. The most important document is your will, which would deal, among other things, with the guardianship of your children. You should also probably have a health care power of attorney, a financial power of attorney, and other documents that deal with your care while you're alive.

MCCAFFREY: You'd need a durable power of attorney, which means it lasts after incompetency. A health care proxy gives another person the right to make medical decisions for you, and you might want a living will, which is an ancillary document that describes the care you would or would not want if you couldn't speak for yourself.

MATHIEU: We're seeing increasing use of the standby living trust, which tells a trustee what to do in case of incompetency or illness. It is fully revocable and amendable by the client. It requires a trustee to act as you wish, whereas a power of attorney only authorizes a person to act as they wish.

To what extent is it necessary to establish trusts if we're not talking about a megamillion-dollar estate?

MCCAFFREY: A revocable trust is for a person who's alive, and there's debate about its value. But once an individual dies and we're dealing with the way property passes to members of the family, most people with an estate in excess of $600,000 or with small children need at least one form of trust. Someone with minor children certainly needs a trust, or the money would go to the child outright and be managed by a guardian subject to the supervision of a surrogate's court. You would want it to be managed by a trustee you would appoint, and you would want to have control over the age at which the children get the money. In the absence of a trust, a child in New York would get the money at age 18, which is not what most people feel is appropriate.

The next issue is whether you need trusts for your spouse. When the marriage is a happy one, most wills leave the bulk of the estate to the surviving spouse, which enables you to defer estate taxes until the death of the surviving spouse. But you can accomplish this with either outright bequests or through a trust, so why pick a trust? You might if you didn't think your spouse were capable of managing money. Or if you were worried that your spouse would remarry and leave all the money you earned to the new spouse. Or if you wanted to make sure your property goes to your children, not to other people, when your spouse dies.

EASTLAND: Also, using a trust doesn't mean that you have to deny a spouse decision-making authority. You can design a trust where the spouse has control over who gets the assets after he or she passes away. Many people want their spouse to have this kind of leverage over the children and grandchildren. If that's the case, you can build the power of appointment--one of my clients calls it the power of disappointment--into the trust.

MATHIEU: That's another reason to have a trust. It enables you to get an impartial arbiter into the act. Think about it. Do you really want to give your brother the problem of dealing with your five kids who can't stand each other?

MCCAFFREY: A fourth reason for a trust might be to protect your spouse from creditors. An individual generally can't protect assets from creditors, but if my husband were in an automobile accident and got sued for millions, I could have made sure there was always something there for him by leaving at least part of what I left him in trust.

EASTLAND: W.C. Fields was a pretty good estate planner, because he always said he didn't want to be a millionaire, he just wanted to live like one. That's what a trust does: takes assets off your books. There are lots of advantages to that, including creditor, divorce, and tax protection.

SEDERBAUM: Let's not forget the generation skipping trust, which is in addition to all the others we've discussed. The GST allows a grandparent, say, to create a trust that passes up to $1 million through the child's generation to a grandchild's generation without having transfer taxes imposed. Some states--South Dakota, Delaware, Wisconsin, Idaho, and Alaska--allow these trusts to exist in perpetuity. But any trust that skips a generation is by definition a lengthy one, and the other 45 states allow trusts to exist for 90 years or more.

MATHIEU: This is an important concept for all transfer taxes--gift, estate, and GST--because assets are distributed when a trust ends. When the person who receives them dies, an estate tax has to be paid. If the trust never ends, the assets never in effect get transfer-taxed.

EASTLAND: This is something for people in their 40s or 50s to think about whose parents are alive. They should at least plant the seed that the best way parents can leave assets to them may be in a trust. The money won't be taxed in the child's estate if the trust is properly drawn up to the $1 million exemption. And it's always better to receive an asset in trust. The children can be named as trustees if the parents think they are responsible, but no creditor or divorce court can take away property that a child receives in trust.

Any other advice for older parents?

MCCAFFREY: They might think about paying tuition for their grandchildren. So long as it's paid directly to the educational institution, there's no gift tax, and it doesn't use up the annual exclusion. Grandparents can also write checks for orthodontist bills and their grandchildren's other medical expenses. It's a way to deplete an estate to reduce estate taxes.

EASTLAND: One thing I've tried to emphasize with grandparents is that gift taxes are cheaper than estate taxes, even though they're the same rate. The way the IRS calculates the estate tax, you pay a tax on the tax of whatever's left to your beneficiaries, which can add up to 122%. The gift tax, by contrast, is 55%. To show how this works, I'll often suggest giving the kids, say, $1 million and having the kids pay the gift tax. The gift then becomes what's known as a "net gift," and the grandchildren wind up with $650,000, vs. the $450,000 they would have received if they had gotten the $1 million as an inheritance.

Are there any other trusts to look at?

MCCAFFREY: Most people should think about a trust to save estate taxes on life insurance. Let's say a husband has $500,000 of life insurance. He should put the policy into an irrevocable trust that says the funds are available for his wife's care if she survives him. She could have a lot of control over the trust, even the right to fire the trustee if the trustee isn't sensitive to her needs. On her death the remaining money would go to the children, free of estate tax, in trust until whatever age the client thinks is appropriate.

What would it cost to set up a life insurance trust?

MCCAFFREY: I'm sure it varies widely, but in my firm it would probably run between $2,000 and $3,000.

That sounds like a lot for a $500,000 policy.

MCCAFFREY: Not when you compare it to what the person is paying in premiums.

SEDERBAUM: Or when you factor in the eventual estate tax burden on that $500,000 if the trust were not established. We're saving something like $250,000.

MCCAFFREY: And you don't simply pull an insurance trust off the shelf when somebody walks in the door. It would be part of the overall estate planning package.

MATHIEU: Trusts by nature are customized to whatever needs you're trying to meet. The other thing to remember is that you have to make assumptions about how long you're going to live and how much you think you'll be spending on retirement living, health care, and so on before you set up the trust. And then you have to review it on a regular basis. It's a dynamic process. You don't just create a trust and file it away in a drawer.

What other tips have you got on insurance?

SEDERBAUM: Here's something to think about. The process of diminishing one's estate for tax purposes is often a difficult pill to swallow because you have to give something away or, as the tax code puts it, "part with the dominion and control" over an asset. It can be hard for someone to give away 100 shares of Microsoft, because he gets benefits from the stock. Life insurance is easy--or let's say it's a lot easier--to give away because it matures after the insured dies. In other words, telling someone it's better to assign ownership rights in a life insurance policy to a trust is a lot easier than counseling him to give away other assets.

MCCAFFREY: Another trust we should mention has to do with the unified credit. Every individual has the ability to give away $600,000 during his or her lifetime, or at death, free of federal estate taxes. In addition, he or she can give everything free of tax to the other spouse. The easy will to write leaves everything to the spouse, and there's no tax until the spouse dies. But at this point, the spouse can protect only $600,000 with the unified credit, and anything over that is exposed to tax. To avoid that, the first $600,000 shouldn't go to the spouse outright but should go into a trust.

Does this trust have a name?

MCCAFFREY: We call it the credit-shelter trust. Others call it a family trust or a family bypass trust. This little technique could save a New York resident $335,000 in taxes on the death of the survivor--and probably more, because that $600,000 is going to appreciate during the surviving spouse's life.

SEDERBAUM: The credit-shelter trust will assume even more importance because both the House and Senate have passed bills that would increase the unified credit to a point where it protects $625,000 next year and $1 million by 2006 or 2007. If the legislation is signed, the children's generation, which now can receive up to $1.2 million free of estate taxes from their parents, could receive up to $2 million free of estate taxes.

MCCAFFREY: There's another piece of important pending legislation, and that's an exclusion of up to $1 million for a family-owned business. If that goes through, I suspect we're going to see the formation of lots of family businesses.

SEDERBAUM: A debate is going on in Congress right now about the entire future of the estate tax. The justification for those who advocate repeal--other than those who would just like to give a boondoggle to the wealthy--is that the estate tax puts such a strain on a family business when the owner dies that the only solution is the liquidation of the business and the end of a dream for that family. I think the debate will lead to changes in the definition of a family business and perhaps in relief for family businesses by minimizing the impact of the tax and extending the time to pay taxes. The pending legislation may be the first step in that direction.

EASTLAND: If the legislation Art is talking about is drafted in a way that allows practitioners and clients to comply in a simple fashion, a lot of octogenarians might run out and buy a family business in the hope they could avail themselves of the benefits of the new law. If it's written in a complex manner, it might not prove that useful a way of protecting the business from taxes. Whatever, it's important to realize that some members of Congress view estate taxes in a schizophrenic manner. They dislike the way they affect family businesses, but they like the idea of high estate taxes.

Politicians schizophrenic? Hard to believe, but you guys are the experts.