Generally, annuities allow for the money you pay to be invested. Interest is earned which will increase, over time, the amount of money available to pay for your funeral. The interest rate it earns and the rate of inflation are important considerations. There may be federal and state income tax liabilities associated with this type of funding, although tax on interest earned is generally deferred until death.
Through this method, the person planning their funeral buys a policy of life insurance, and directs payment of the death benefit to the funeral home if allowed by law. It is important to know how much insurance you have to buy to secure a guaranteed funeral; if the death benefit is adjusted for inflation or level in amount; and if the policy will issued regardless of your health, or whether your health may disqualify you from coverage. Many policies will pay the entire death benefit even if the total premiums have not been paid at the time of death. Death benefits from insurance policies are generally exempt from income tax liability to the insured on growth in the policy death benefit.
Savings accounts (sometimes referred to as P.O.D. - payable on death-accounts) can be established for the purpose of paying for a funeral. The interest earned will increase, over time, the amount of money available to pay for the funeral. Interest earned each year is usually subject to income tax. P.O.D. accounts are usually held jointly by the consumer and funeral director, and upon the consumer's death the account automatically belongs to the funeral director. The interest rate any savings account earns and the rate of inflation are important consideration. Usually, there is no guarantee that the funeral will be totally paid, and the estate or family may be responsible for any shortfall. Usually, any excess funds belong to the funeral home. Jointly held Certificates of Deposit (CDs) have the same general considerations.
Funds may be placed in a trust fund at a bank and invested to earn interest to increase the funds available to pay for the funeral. Interest may remain in the trust or may be withdrawn by the funeral firm depending on your state law. In either event, generally, you are responsible for federal income taxes on the interest earned each year.
Some states allow the funeral home to keep some of the money as an initial charge, so it is important to know if all or only part of the money is deposited, especially on non-guaranteed contracts. Administrative expenses are also generally charged against the trust. Some states restrict the amount that the trustee may charge for administering the trust. You should ask about these charges before you sign anything. There may also be state tax liabilities associated with this method of funding.
Other types of funding are available; however, life insurance, bank truest, annuities and savings accounts are the most common.