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Originally published Sunday, November 25, 2007 at 12:00 AM

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"Stupid" Investment of the Week

Irrevocable funeral trusts

There are worse things than making a bad financial decision. Death, for instance. But one thing that could actually make death worse would...

Syndicated columnist

There are worse things than making a bad financial decision.

Death, for instance.

But one thing that could actually make death worse would be having a bad financial decision tied to it.

And for many people, one such bad choice would be an "irrevocable funeral trust," an insurance/financial-planning device that sounds good for almost everyone, but which for many people would be a Stupid Investment of the Week (or perhaps for eternity).

Stupid Investment of the Week highlights the conditions and characteristics that make an investment less than ideal for the average consumer, in the hope that spotlighting trouble in one case will make it easier to root out danger elsewhere. From a regulatory standpoint, insurance products are not investments, but they qualify for this column because the consumer is expecting a return on his or her money, either in terms of the ultimate benefit payout or the protection the coverage provides.

The column is not intended as an automatic sell signal, but that's irrelevant for an irrevocable trust, because there's no getting out of it. More important, however, is that estate-planning attorneys and elder-law specialists say that a funeral trust is a good choice for people in very specific circumstances, so some people who have one may actually have made a smart move.

An irrevocable funeral trust — as sold by FuneralTrusts.com — is a single-premium life-insurance policy, typically with a death benefit in the range of $10,000 to $15,000 that is designated for covering funeral costs.

It's different from pre-planning a burial, however, because that is done in conjunction with a funeral home. A key selling point behind the trusts is headline-grabbing cases where funeral homes have gone out of business; another is that the trust provides flexibility in picking a service provider, so that the family is not locked into using a certain funeral home.

It is similar to that kind of planning, however.

A key issue behind funeral planning is the need for long-term medical care and the desire to shield some assets from nursing homes or Medicaid. Not only is there a carve-out that allows an individual to set aside money for a funeral, but money used for that purpose "beats the clock;" where most assets must be moved out of an individual's name and/or accounts well in advance of needing long-term care, funeral monies can come out on the eve of moving into the nursing home and just before needing Medicaid

"The idea behind a funeral trust is to allow a senior citizen to put some money aside so that if they do go into a nursing home, they have something set aside for their funeral, money that is exempt from Medicaid," says Mike Odell, national sales manager for FuneralTrusts.com. "We approach the funeral trust planning as Medicaid planning, and not from an investment standpoint."

Approached that way, estate planners and elder-law attorneys say the funeral trust makes sense, provided it's done at the last possible minute. There's no advantage to executing an irrevocable funeral trust well in advance.

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The problems are buried, if you will, in the details.

For starters, the insurance company is the trustee of the trust, instead of someone you know.

"You're turning the money over to an insurance company, and then you will need the money quickly — because funeral homes can be pretty demanding when it comes to payment — and you have to wonder if the trustee has an incentive to pay the claim promptly," says Stephen Ziobrowski, an estate-planning attorney at Day Pitney in Boston. "At the very least, you're creating another step in the dance of getting the money to the funeral home; when the time comes, you'll be rushing around to prove to the insurance company that they must pay the claim now. If they don't, you might have to come up with money to pay for the funeral while you wait for the claim to settle."

A funeral trust is a simple legal document, similar, in fact, to what many funeral homes use when having an individual prepay for services. In some cases, the funeral homes actually use payments to establish insurance policies, which wipes out the argument of "which is safer, a funeral home or an insurance company?"

From an investment standpoint, the funeral trust is a horrible buy, as it effectively involves taking a lump sum of money — which may come from a fully paid-up policy in the form of something called a "1035 exchange" that swaps one policy for another — and getting it back at the end with little or no interest.

"The insurance companies will come in and say 'We will charge you 12 grand, and we will pay you 1 to 3 percent, and use the money to pay for the funeral,' " says Warren Baker of Baker, Braverman & Barbadoro in Braintree, Mass., a partner in the Elder Law Resource Center. "You'll pay about $12,000 to get $12,000 in insurance, and you could do that on your own ... in a bank CD if you had to."

While most people think of trusts costing thousands of dollars to establish, that's wrong when the dollars are small and the work is routine. Almost any lawyer who can draft a simple will could establish an irrevocable trust — naming a trustee of your choosing — designated to pay your funeral costs and getting the long-term-care financing benefits.

And if the $12,000 can be invested at, say, 5 percent a year, the $600 gained in the first year alone will more than pay for the cost of setting up the trust.

Ultimately, some insurance-industry watchers believe irrevocable funeral trusts are being sold by agents who have longtime customers, as a kind of "last sale of a lifetime," one final way to squeeze a dollar out of the customer.

Says David Bohannon of Consultants Corner, an insurance advisory firm in Louisville, Ky.: "You're adding a whole other entity into what is a very difficult time for the family. The trustee knows nothing about you at all, except that you gave them some money and they are supposed to pay a funeral home with the balance to an estate or an individual. It won't be the guy who sold you the policy, that's for sure. ... Don't just question whether this makes financial sense, question if this is right for your family."

Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe's Stupid Investment of the Week or a comment about this week's column, you can reach him at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.

2007, MarketWatch

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