Wealth Insights

The Unsung Benefits of a Funeral Trust

While insurance-company backed pre-need plans are taking priority in the marketplace, trusts can be more beneficial in the long term for funeral directors.

Americans buy pre-need funeral plans to the tune of $5 billion a year, largely through funeral homes. The majority of these plans, approximately 80 percent, are funded through insurance policies while the remainder are funded through funeral trusts.

Pros and cons exist for each, so an individual’s situation should be assessed before determining the best solution. And while insurance-company-backed pre-need plans are taking priority in the marketplace, trusts can be more beneficial in the long term. They have the potential to offer the greatest financial upside for funeral directors and tend to be less expensive for customers because a funeral is typically fully funded after four years of payments into a trust.

“Insurance commissions are a big draw for funeral directors who get that money up front,” says David Falconer, Funeral and Cemetery Trust Services Manager with Regions Bank.

For pre-need insurance products, there are chargebacks to the funeral home director in commission in the first year of the policy. Also, many policies have limited death benefits in the first two years, meaning the customer gets only the amount of money he or she has paid in premiums plus 6 percent interest to go toward the funeral.

Security Versus Returns

In the face of investment returns and costs, why do insurance-backed plans continue to thrive? It’s because of the financial security they provide to both the customer and the funeral home operator.

With insurance, customers lock in a funeral cost and level of service from the time the policy starts, and the funeral director earns commissions from the insurer underwriting the policies.

“Those commissions are a big draw because they allow funeral directors to quickly and safely recoup their preneed marketing expenses,” says Falconer. In addition, the funeral home receives some income from the insurers’ investments. In 2017, the average cost of a burial was $7,360, according to the National Funeral Directors Association’s 2017 General Price List Survey.

However, insurance-backed plans are heavily regulated. In most cases, these plan investments are tied to 10-year U.S. Treasury bonds, which have yielded less than 3 percent annually for most of this decade. Trust-backed plans work in a similar fashion to insurance backed plans – they are a promise of funeral services in exchange for the amount invested in the trust. But the way funeral home owners earn money off the trust is different and varies by state.

Some states allow funeral home owners to use some of the trust money to recoup marketing expenses. But in most cases, funeral directors can only draw upon the trust for investment income after it funds the funeral costs. They must wait instead of earning a commission up front.

Trust-based pre-need plans are typically governed by a “prudent investor” rule that permits trusts to invest in a broader and more varied set of assets. This offers funeral directors a more diverse portfolio as well as access to higher-return investments. According to Falconer, preneed trust returns have averaged between 5 percent and 6 percent in recent years.

The Trade-offs of Trusts

In cases in which customers die within a year or two of purchasing a pre-need plan, insurance-backed policies are most beneficial for funeral homes, as funeral costs are already covered and the funeral home has a commission. When a funeral trust isn’t fully funded at death, customers’ descendants are responsible for the balance, and the funeral home receives less income.

The investment income generated from a trust usually equals the amount of the commission after four years. Given that the average pre-need plan doesn’t mature for about nine years, according to Falconer, eventually the math favors trusts.

Most funeral homes offer both insurance- and trust-backed plans and may emphasize one type of plan over the other. But for customers steered toward insurance-based plans, there are trade-offs for security.

Insurance-backed plans immediately guarantee full funding of the funeral, but over time, accumulated premium payments on pre-need policies can outpace the cost of the actual funeral. Falconer notes that the premiums can eventually equal two to three times the cost of the funeral.

“A lot of insurance companies have increased their premiums significantly to offset the commissions that they’re paying, and those rates just keep going up,” he says.

Modern funeral trusts are often pooled into a master trust, allowing funeral directors to pay taxes on investment income out of the trust itself, rather than sending tax documents to the customers.

Falconer sees the merit in both insurance- and trust-backed pre-need plans, and emphasizes balance is the key. Nonetheless, he feels funeral home owners undervalue trusts, which have the potential to turn into powerful revenue-generating tools. “You’re never going to get the same sort of profit potential from insurance,” he says.

See how you can improve your returns by contacting Regions Funeral and Cemetery Trust Services, which focuses solely on funeral home and cemetery owners’ trust needs.