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Many persons who have accumulated wealth during their lifetime die without a valid will. When this happens, the decedent’s property passes by intestate succession to the decedent’s heirs at law according to law. In other words, if you don’t have a will, the state will make one for you. All fifty states have laws of this sort. The North Carolina Intestate Succession Act is codified at Chapter 29 of the General Statutes.

The purpose of intestate succession statutes is to distribute the decedent’s wealth in a manner that closely represents how the average person would have designed his or her estate plan had that person had a will. However, this default can differ dramatically from what the person really would have wanted. Even where is it is known what the person intended, no exceptions are made where no valid will exists. Nor are there any exceptions made based on need or special circumstances. As will be explained below, in North Carolina an intestacy can create unintended (and sometimes tragic) consequences.

The North Carolina Intestate Succession Act

Under the Act, close relatives take property instead of distant relatives. The classes of relatives whose members receive property under the Act include the decedent’s surviving spouse, descendents (children, grandchildren, etc.), parents, descendents of decedent’s parents (siblings, nieces and nephews), grandparents, and descendents of grandparents (aunts and uncles and cousins). Adopted descendents are treated the same as biological descendents. If none of the above-named classes of relatives include any persons qualified to take the estate, the property “escheats” (goes by default) to the state.

The North Carolina Act is considerably different from the Uniform Probate Code and many other states’ acts. The way in which a surviving spouse is treated upon intestacy should alone be enough to entice most individuals to have an enforceable will prepared to avoid the following situations.

Share Of Surviving Spouse

Under the Act, a surviving spouse receives the entire estate ONLY if the deceased spouse is not survived by a child or a parent. If the deceased is survived by one or more children or grandchildren (who could be step-children or step-grandchildren of the surviving spouse) and/or one or more parents, the surviving spouse will take only a share. Children and grandchildren are referred to below as “descendants”. The rules are as follows:

If there is one descendant surviving, the surviving spouse is entitled to the first $30,000 of personal property and one-half of the rest of the real and personal property in the probate estate.

If there are two or more descendants, the surviving spouse takes the first $30,000 of personal property and only one-third of the rest of the estate.

If there are no surviving descendants, but the deceased is survived by one or more parents, then the surviving spouse is entitled to the first $50,000 of personal property plus one-half of the balance of the estate.

It takes no imagination to see the havoc that can be created by an intestacy. An individual leaving a young family will subject one-half to two-thirds of his or her estate to continuing clerk of court supervision until minor children are 18 because a guardianship will likely be necessary. If one member of a childless couple married for a long time dies intestate with a surviving parent, that parent will take up to one-half of the estate. The situation can be even more critical in second marriage/second family situations.

Share of Descendents

Under the Act, if no spouse survives but descendents of the decedent survive, the descendents take the entire net estate by “representation.” (See discussion of “Representation,” below.)

Share of Parents

Under the Act, if a decedent is not survived by a spouse or descendents, the entire net estate passes to the decedent’s parents equally or, if only one survives, to the survivor.

Share of Other Relatives

Under the Act, if a decedent is not survived by a spouse, descendents, or parents, the entire net estate passes to the decedent’s siblings or the descendants of any deceased siblings (nieces and nephews).

If there are no siblings or descendants of siblings, then the estate is divided among the paternal and maternal relations (grandparents, aunts, uncles, cousins) of the decedent.

Net Estate

The “Net Estate” is the amount left for distribution to heirs after all debts, family allowances, taxes, and administrative expenses have been paid. “Family allowances” include a $10,000 year’s allowance to surviving spouses and $2,000 with respect to each surviving minor child.

Filed Under: Wills (or Not!) Tagged With: , , ,

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If a will is valid, it is effective until it is changed, revoked, destroyed, or invalidated by the writing of a new will. Changes or additions to an otherwise acceptable will can be most easily accomplished by adding a codicil. A codicil is a document amending the original will, with equally binding effect. Therefore, a codicil must be executed using the same formality as the original will. Wills cannot be changed by simply crossing out existing language or adding new provisions, because those changes do not comply with the formal requirements of will execution.

Changes to an individual’s personal property may prompt a change to an existing will. Although many states allow a will to specify that personal property (property other than money and real estate) is to be distributed in accordance with instructions provided in a separate document, North Carolina is not one of those states. A document in existence at the time a will or codicil is executed may be incorporated by reference and have effect. But if the intent is to continuously update a “memorandum” or “letter” after the will is executed and have the updated document be of legal effect, it will not work in North Carolina. That being said, wills are often drafted that refer to a statement or a memorandum that is a list of personal property the decedent wishes for the executor to distribute in a certain manner (Grandma’s china to Sue, Grandpa’s shotgun to Ned). Many individuals do not wish to “clutter up” an already lengthy document (a tax planning will can easily run 30 or more pages) with relatively minor items that may change over time. Such lists and statements are useful as long as the client understands that the list might be morally persuasive to the Executor and Beneficiaries, but the list will have little authority beyond that. I suggest that if certain items are important enough and may be the subject of contention, list them in the will.

An outdated will may not achieve its original goals because its underlying assumptions have changed. Additionally, changes in probate and tax law may change the effectiveness of certain provisions. This is especially true as tax law changes accelerate. What may have been sound tax planning a few years ago could be disastrous now. If a will is based on outmoded circumstances, for example if a chosen devisee has died or has alienated the testator, the probate period may be extended as the court determines how to construe the old provisions. Wills should be reviewed at least every two years, as well as upon major life changes such as births, deaths, marriages or divorces, and major shifts in a testator’s property. Because state law governs wills, if a testator moves to another state, the will should be reviewed for compliance with the new state’s laws. If you have recently moved to North Carolina, please call us to make arrangements to review your estate planning documents.

As long as the testator is mentally competent, his or her will can be revoked entirely without replacement by a new document. A testator can revoke a will by intentionally destroying, obliterating, burning, or tearing the will. If the will was executed in multiple originals, or if additional copies exist, those should be treated in the same fashion. If undertaken, however, the testator would be wise to have the revocation witnessed and recorded to avoid future contentions that the will is still valid, but has been lost.

A word of caution: Revoking a will without preparation of a new will result in an intestacy if you die before preparing a new will. Serious problems can result from an Intestacy. Please see discussion at Intestacy: When You Die Without a Will – Why to Avoid It.

Filed Under: Wills (or Not!) Tagged With: , ,

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A Few Thoughts

Many people are interested in making funeral arrangements well in advance of the need. Any paperwork completed ahead of time will help simplify things when death occurs. Taking charge of your own planning insures your wishes are carried out and spares loved ones from the emotionally draining task of doing so later. Preplanning allows you to make advance financial arrangements. Finally, preplanning can be a valuable tool if Medicaid planning for long-term care becomes a necessity.

Details such as pallbearers, memorial donations to certain organizations and church officials to conduct the service can all be tentatively arranged and then changed, if necessary, when finalizing actual arrangements. It is easier to go over information already on file looking for possible changes than to start from the beginning. Also, many churches have formal or informal systems for keeping your funeral wishes on file – talk to your pastor, priest or other clergy.

When meeting with a licensed funeral director, you might want to ask for prices on everything to get an idea of what kind of cost will be involved. When making pre-arrangements, the funeral home representative will give you the different preneed options offered by the funeral home. Those options will be discussed further below.

You may be interested only in pre-arranging the funeral service and/or type of funeral and may not be interested in making specific selections of merchandise such as caskets, vaults, etc. If you select merchandise and actually make specific funeral arrangements, you will have an idea of how much money to set aside for the funeral. In either case the funeral home will be able to give you a copy of the arrangements decided upon. Remember to take into considerations that inflation may cause the price to increase with time.

There are a number of common ways to insure a funeral is properly paid for in advance.

PRENEED FUNERAL CONTRACTS

Preneed contracts are being marketed extensively and offer the opportunity for a person to fully consider his or her needs and wishes and control the cost and nature of funeral services desired. The contracts vary in terms of coverage and should, like any other purchase involving a substantial sum of money, be reviewed carefully before execution. We will be happy to work with you in that part of your overall estate planning process.

Preneed funeral contracts are governed by Article 13D of Chapter 90 of the General Statutes of NC and are under the jurisdiction of the NC Board of Funeral Service. NC law requires that any seller of contracts for preneed funeral arrangements must apply for and obtain a license from the NC Board of Funeral Service. Discussions concerning arrangements and/or pre-arrangements may only be handled by a person licensed by the State Board of Funeral Service, insuring that a trained professional provide you with correct information and advice. Do not contract with any seller who does not have such a license. With most well-known and established funeral service providers, this should not be a problem.

PRE-FINANCING ARRANGEMENTS

Two words to become familiar with in the area of pre-financing a funeral are revocable and irrevocable. A revocable contract may be canceled at any time by the purchaser. An irrevocable contract cannot be canceled but its benefits can be transferred to any provider of your choice at any time prior to need.

In order to qualify for medical assistance (Medicaid) an individual is allowed to shelter funds set aside from payment of funeral expenses as long as the funds are put aside in an irrevocable contract. Many of the preneed contracts are set aside as irrevocable for this purpose. See The Medicaid Planning Process.

TYPES OF CONTRACTS

In North Carolina there are primarily two different ways to pre-finance or pre-pay for a funeral which should cover all costs incidental to a funeral service.

I. PRENEED TRUST AGREEMENTS. In such an arrangement, money to pay for the funeral is placed in a bank, trust company, savings bank, or savings and loan association in North Carolina. The licensed funeral home which acts as trustee for the funds may withdraw the funds put in trust once it has performed the preneed contract.

Some things to consider with this contract include:

A. Taxes on the interest earned — No matter what type of account your money goes into (savings, CD, etc.) income taxes must be paid on the interest earned. The funeral home acting as trustee for the account should advise you as to the amount of earnings on the account and should provide you with reporting information.

B. Earnings on the account — The interest earned on the account will be added to the trust, therefore, allowing it to grow until the funds are needed to actually pay for the funeral. Hopefully the earnings on the account will cause the trust to grow to keep up with inflation. Some funeral homes offer inflation-proof contracts which guarantee the purchaser that the pre-arranged funeral will be handled no matter what the cost at the time of death.

C. Fees — If you, as purchaser, agree and the contract is funded by a trust deposit, the funeral home may retain up to 10% of the payments as administrative expenses provided; however, it gives credit for the amount retained at the time of need. If the trust is transferred to another funeral home, the original funeral home may retain up to 10% of the trust amount as administrative expenses and does not have to give credit for the retained amount.

II. INSURED PRENEED ARRANGEMENTS. Insurance policies can be used as a means to finance preneed contracts in North Carolina. The proceeds of a specially designed policy, for a specified amount of money, pay the preneed contract amount at the time of need.

Because there are many different kinds of insurance options available, you should look over the policies and plans carefully. For example, in addition to trust-funded inflation-proof preneed contracts, you will also find inflation-proof insurance-funded contracts.

All preneed contracts, whether trust funded or insurance funded, must be recorded with the North Carolina Board of Funeral Service. A filing fee of $18.00 must accompany each contract. After filing and within thirty days, the recording of the contract is acknowledged in writing to you, as purchaser, by the Board.

Filed Under: Miscellaneous Tagged With: , ,

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Robert A. Mason, CELA

Originally published in The Will and the Way, NC Bar Ass’n (3/2003)

Ch-ch-ch-ch-changes
Turn and face the strange ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange ch-ch-changes
Just gonna have to be a different man
Time may change me, but I can’t trace time

David Bowie, Hunky-Dory, 1972

This Spring or Summer should be an interesting time to be an estates and trusts lawyer or, for that matter, a trust officer in North Carolina. Change, radical change, is in the air. As is the case with most change, however, this will be a good news-bad news story. The bad news is that there will be much to learn, and for those used to the comfortable old way of doing things this will be a decidedly uncomfortable time. The good news is that the opportunities for designing trusts that comport with modern portfolio or “total return” theories of investment and for redesigning stodgy old income rule trusts just waiting for litigation are about to open. Regardless of how you may feel, change is coming and is inevitable unless North Carolina wishes to remain one of the fewer than ten states that have not responded to the unitrust/equitable adjustment riptide that has swept the national beach over the past two years.

The modern concepts involved in the changes coming are a response to the age-old trustee’s dilemma: How to invest for income and asset appreciation, how to keep the income beneficiaries happy and the remainder beneficiaries happy . . . and not get sued in the process. The old ways of doing things are imbedded in the prudent man rule of Harvard College v. Armory, 26 Mass. (9 Pick) 446 (1830), and in the categorizations of principal and income that have been fixtures of older versions of the Principal and Income Act and the Internal Revenue Code for decades. The old strategies worked reasonably well in markets accustomed to somewhat elevated but stable interest rates, moderate but steady appreciation of equities and significant distributions of dividends by issuers. Those days are history. The new way of doing things will be based on increased trustee flexibility to invest for total return (income plus appreciation) under a scheme that will allow trustees to reclassify capital gain as income (and vice versa) or to elect to pay a unitrust amount and call it ‘income’ regardless of actual trust income. With the age-old dilemma off her back, the trustee can invest for total return and everyone will be happy (theoretically).

Well over forty states (the numbers will increase as the legislative season heats up) have either adopted or are considering total return legislation, and the Internal Revenue Service is moving full bore with a complete rewrite of its income-versus-principal regulatory scheme that should be in place by late Spring. On Jan. 29, 2003, the Bar’s Executive Committee considered and approved the North Carolina Principal and Income Act of 2003 put before it by our section’s legislative committee. It is now part of the Bar Association’s 2003 legislative agenda. The Proposed Legislation includes both an equitable power of adjustment and the ability to convert an income rule trust to a unitrust. Further references in this article to “Proposed Legislation” or “Prop. N. C. G. S.” are to the Bar’s legislative proposal.

This article discusses the trustee’s dilemma, outlines the modern response to that dilemma, and gives a reading tour of the key points of the Proposed Legislation and the proposed Treasury regulations.

The Current Situation

Since the 1930s, most, if not all, states have provided statutory default definitions of income and principal for purposes of receipts and disbursements from a trust or estate. The default settings take the form of some variation of one of the versions of the Uniform Principal and Income Act, notably the Uniform Principal and Income Act of 1931, the Revised Uniform Principal and Income Act of 1962 and the Revised Uniform Principal and Income Act of 1997 (which act is a subject of this article and, I predict, will be enacted in all but fewer than five or six U.S. jurisdictions by the end of 2003). North Carolina’s current version, enacted in 1973, is a version of the Revised Uniform Principal and Income Act of 1962 and is codified at N.C.G.S. Chapter 37.

The reason one may view the applicable Principal and Income Act as a set of “default provisions” is because the specific provisions of a trust document or will may override the provisions of the act; in the absence of any (or clear) directions under the document, however, the provisions of the act will control. The provisions of the Principal and Income Act are also extremely important because document drafters will invariably fail to address every exigency, the provisions of a Principal and Income Act will provide evidentiary standards of “reasonableness” in the event of inevitable trusts and estates litigation, and numerous provisions of the Internal Revenue Code and the Treasury Regulations work with reference to state law (“if local law so provides . . .”).

The Uniform Principal and Income Act of 1931 (UPIA 1931) and the Revised Uniform Principal and Income Act of 1962 (RUPIA 1962) have governed the classification of trust receipts from various sources for purposes of determining whether those receipts will benefit the income beneficiaries or the remainder beneficiaries, using traditional notions of what is “income” and what is “principal”. Pursuant to those acts, trustees labeled dividends, interest, royalties, lease payments and the like as “income,” and they labeled capital gains and other appreciation of assets as “principal.”

While some version of the Principal and Income Act assisted with trust asset classification issues, the prudent man rule, first enunciated in Massachusetts in 1830, governed trustees’ management of trust assets. The prudent man rule requires trustees to “observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.” Harvard College v. Armory, 26 Mass. (9 Pick) at 461. The prudent man standard later appeared as the Model Prudent Man Rule Statute (1942) and in Section 7-302 of the Uniform Probate Code (1969). In fact, the Prudent Man Rule governs ERISA trustees under Section 404(a)(1)(B) of ERISA.

The Prudent Man Rule works if the primary concern is the preservation and growth of capital (principal), as is the case under most employee retirement plans subject to ERISA or many other trusts that are designed to conserve or grow capital for a single beneficiary (or class of beneficiaries). Even in the case of an “income rule” trust in which all income (as defined under the instrument or the local version of the Principal and Income Act) is to be paid to an income beneficiary for life, remainder to certain other beneficiaries, the Prudent Man Rule may continue to suffice if the trust investments (and for that matter the broader financial markets) are generating reasonable and stable levels of income.

However, the markets and the economy of the last twenty years or so have given everyone a wild ride. Just ten years ago a trustee could hold a portfolio of 60 percent equities and 40 percent bonds and expect an income return of over 5.5 percent. Today that same portfolio might return less than 3 percent income yet produce dramatic capital appreciation. See Lyman W. Welch, “Policy Differences in Total Return Laws,” at www.leimberg.com/tapes/policy_differences.html (adapted from an earlier article in Trusts & Estates (June 2002). Also, new investment vehicles such as derivatives, options and asset-based securities, once novel, now common, generate receipts allocable to principal under current rules. Kimberly Stogner, “A Look at the Uniform Principal and Income Act of 1997,” The Will and the Way 18 (Nov. 1998). In this environment, the investment community began to develop models based on “total return” – a view that the prudence of trust investments should not be determined with respect to an examination of individual investments, but rather an examination of overall investment mix, and whether through wise diversification a trust is generating adequate levels of total return (income plus principal growth). As concepts of modern portfolio theory and total return investing have gained favor, there has been a growing disconnect between the newer theories of investing under the traditional Prudent Man Rule and classifying investment returns as either income or principal under the older notions of UPIA 1931 or RUPIA 1962.

Prudent Investor Act

As a result of increased acceptance of total return investment and modern portfolio theory, the need for statutory guidance other than the Prudent Man Rule became readily apparent. In 1994 the National Conference of Commissioners of Uniform State Laws (the Commissioners) adopted the Uniform Prudent Investor Act (to avoid confusion with UPIA this article refers to the Uniform Prudent Investor Act as the “Investor Act”). The Investor Act, while continuing to balance the income beneficiary’s right to a reasonable distribution of income against the remainder beneficiary’s continuing interest in preserving and growing principal, focuses more on total return performance and the need to balance overall risk versus trust performance. The Investor Act imposes several duties on a trustee: (i) loyalty, (ii) impartiality, (iii) pursuit of an investment strategy that considers both reasonable production of income and safety of capital, and (iv) diversification of trust investments. North Carolina adopted the Investment Act in 1999 as Article 15 of Chapter 36A of the General Statutes, effective January 1, 2000 (the general rule is codified at N.C.G.S. § 36A-162). According to N.C.G.S. section 36A-162(c)(5), one of the elements that a trustee must consider as part of the overall trust investment strategy is “[t]he expected total return from income and the appreciation of capital . . . .”

Promulgation of the Investor Act for consideration by the states was a good start, but it also created problems. Trustees found themselves in a squeeze between the Investor Act mandate to generate total return on an overall investment strategy and the need to generate reasonable income to pay to an income beneficiary. Often, a trustee cannot have it both ways. In fact, as noted above, in the market of the late ‘90s it may have been the case that a prudent total return strategy would not generate reasonable income. The Commissioners reacted swiftly, and by 1997 they issued the Revised Uniform Principal and Income Act of 1997 (“RUPIA”).

Uniform Principal and Income Act of 1997 and the Power to Adjust

RUPIA provides the second leg for a trustee to stand on when implementing a trust investment policy comporting with modern portfolio theory by granting trustees powers to make adjustments between income and principal. Many states have augmented the power to adjust with a mechanism to convert an income rule trust to a unitrust, discussed below. The Proposed Legislation takes this tack. Either approach enables a trustee to, in effect, reclassify as principal what might otherwise have been income and vice versa. Under powers of equitable adjustment, a trustee may reclassify a certain amount of principal or capital gain as income in order to assist the trustee in realizing a reasonable “income” stream to the income beneficiary. On the other hand, a unitrust payout is a payout equal to a fixed percentage of a trust’s assets for a given period.

Part 1 of Article 1 of Proposed N.C.G.S. Chapter 37A tracks RUPIA nearly verbatim. Accordingly, further references to RUPIA sections in this article also may be taken as references to sections of the Proposed Legislation (e.g., RUPIA § 103 is almost identical to Prop. N.C.G.S. § 37A-1-103). RUPIA is available for download or browsing at National Conference of Commissioners on Uniform State Laws website, www.nccusl.org/nccusl/ (select the “Principal and Income Act” from the drop down menu entitled SELECT AN ACT).

RUPIA section 104 (a) provides:

A trustee may adjust between principal and income to the extent the trustee considers necessary if the trustee invests and manages assets as a prudent investor, the terms of the trust describe the amount that may or must be distributed to a beneficiary by referring to the trust’s income, and the trustee determines, after applying rules in Section 103(a), that the trustee is unable to comply with Section 103(b).

Obviously, three conditions must apply for a trustee to make an equitable adjustment. First, the trustee must be acting as a prudent investor, which the Commissioners’ comments make clear could be satisfied under a common law standard as well as taken in a jurisdiction in which the Uniform Prudent Investor Act applies. Second, the trust must define distributions to at least one beneficiary with respect to the trust’s income. Third, the trustee must determine that she is unable to allocate income in a fair and impartial manner (as required under Section 103 (b)). This would be the case under an income rule trust if, for example, the trust realized significant asset appreciation or capital gain as a result of the trustee’s pursuit of a total return investment policy under the Investment Act that nevertheless generated little or no income in the form of dividends or interest.

RUPIA section 104(b) provides a non-exclusive laundry list of items a trustee should consider when electing to make an equitable adjustment, and Section 104(c) provides a number in situations in which a trustee may not make an adjustment (including a situation in which the trustee is a beneficiary of the trust).

RUPIA provides two very strong protections for a trustee making an election to adjust, no doubt in response to concerns that the breadth of trustee discretion would simply invite litigation. First, RUPIA section 103(b) provides that “[a] determination in accordance with this Chapter is presumed to be fair and reasonable to all the beneficiaries.” RUPIA section 105(a) provides that a “court may not order a fiduciary to change a decision to exercise or not to exercise a discretionary power conferred by this Act unless it determines that the decision was an abuse of the fiduciary’s discretion.” Strong medicine. Potential plaintiffs must rebut a presumption of “fair and reasonable” conduct, and then prove an abuse of discretion.

The equitable power to adjust is not without its critics. Some criticize the powers as difficult to administer due to little guidance. See Mark T. Edwards, “Trusts for the New century – The Third Paradigm,” The Will and the Way, Nov. 1998 at 5, updated and reprinted at www.leimberg.com/tapes/edwards.html (hereinafter “Edwards”). Further, once an adjustment is made, the trustee is in the position of having to continuously monitor her actions with the full knowledge that her decisions will be subject to 20/20 hindsight.

Nevertheless, the overwhelming majority of states that have adopted RUPIA have included the Section 104 equitable powers of adjustment. Perhaps most states recognize that the criticism is unduly harsh in view of the statutory protections (discussed above) offered the trustee; many states may also recognize that adopting the unitrust option can provide the second alternative of conversion to a unitrust, which may provide an even safer alternative for the trustee.

About half of the states adopting or considering RUPIA have added a unitrust feature. The virtues of the power to adjust as opposed to the unitrust conversion feature have been subject to lively debate in the Will and the Way. See Edwards (virtues of unitrusts) and Graham D. Holding, Jr. and Christy Eve Reid, “A Different Viewpoint,” The Will and the Way, Feb. 1999, 1 (virtues of discretionary powers). The Proposed Legislation, following a number of states and perhaps influenced by our own either-or debates, includes both the power to adjust and the unitrust feature. A trustee generally may choose either approach under the Proposed Legislation.

Unitrust Conversion

Unitrusts have been used since 1966 in the planned giving context. Perhaps lingering concerns with powers of equitable adjustment, combined with over 30 years of happy experiences managing charitable remainder unitrusts, led many states to explore adding unitrust conversion features to their statutes. For a number of years, some brave and adventuresome practitioners have been drafting private unitrusts and expounding upon their virtues. In certain contexts, however, for every issue a unitrust resolved it raised significant tax issues. While many of the tax issues could be addressed through skillful drafting and planning, not all practitioners have the requisite level of sophistication to plan and draft around those issues. The Internal Revenue Service has recognized the validity of unitrusts by proposing “soon-to-be-final” regulations that encourage the use of unitrusts if “the terms of the governing instrument and applicable law” so allow. The regulations and tax implications will be discussed further below.

With a green light from the Internal Revenue Service, Delaware first enacted a unitrust statute in 2001 with a thinly veiled invitation to trustees to “move on up to Dover” (the legislative notes say that the provisions are available to current domestic trusts and trusts that move to Delaware). Del. Code Ann. § 12-35-3527 (available online at www.delcode.state.de.us). About half of the states that have adopted equitable powers to adjust in the adopted versions of RUPIA have added unitrust provisions. As discussed (as well as in other issues of The Will and The Way) a unitrust permits a trustee to focus on total return, which is simply investing for maximum return (regardless of whether the return is in the form of traditional income or appreciation of principal) within an acceptable level of risk. With an investment philosophy that emphasizes maximum after-tax returns and long term capital growth everyone wins: the “income” beneficiaries receive a larger unitrust payout and the remainder beneficiaries will eventually realize a larger possessory interest. Under the unitrust approach, the greater the total return the trustee is able to realize, the greater the dollar value of the unitrust payout and the greater the remaining trust corpus will be for the remainder beneficiaries.

Those states that have adopted (or are considering) unitrust legislation have generally considered either a “Delaware model” statute (a 3% to 5% unitrust rate with greater trustee flexibility) or a “New York model” statute (a 4% payout rate with less trustee flexibility). The Proposed Legislation (in Part 2 of Article 1) follows the Delaware model nearly verbatim.

Numerous studies have been conducted with respect to setting an optimum unitrust payout percentage. See, e.g., U.S. Trust Co., “The Well-Adjusted Trust: Revisiting the Principal and Income Act (1997)”, Practical Drafting 6918 at 6948-49 (July 2002) (hereinafter “U.S. Trust, Practical Drafting); Robert B. Wolfe, “Estate Planning With Total Return Trusts: Meeting Human Needs and Investment Goals Through Modern Trust Design”, 36 Real Prop. Prob. & Trust J. 169, 208-13 (2001). Computer modeling seems to suggest payout rates of between 3 percent and 5 percent work well for trusts invested primarily in equities, especially if combined with a “three year smoothing rule” (discussed below). Robert B. Wolf and Stephen R. Leimberg, “Total Return Unitrusts: The (TRU) Shape of Things to Come”, www.leimberg.com; see, also, U.S. Trust, Practical Drafting at 6948-50. A thoughtful selection of a unitrust payout rate should depend upon whether distributed capital gains will be treated as part of distributable net income (DNI) and taxed to the income beneficiary (justifying a higher rate) or will remain as non-DNI capital gains and be taxed in the trust (justifying a lower payout rate). Of course, higher payout rates, especially if coupled with a longer anticipated payout term, will favor the income beneficiary, and lower payout rates, especially coupled with a shorter anticipated term, will tend to favor the remainder beneficiaries. In the proposed regulations, the IRS has placed its imprimatur on the 3 percent to 5 percent range. The decision to include capital gains in DNI, and the impact of that decision on payout rates and trustee impartiality, is discussed further below.

Selecting the appropriate unitrust percentage has not been the only concern with respect to creating a sustainable trust. Most unitrust statutes contain a “smoothing rule” that averages the value of the trust assets over a three-year period. The purpose of this rule is to protect current beneficiaries from a sudden loss of income and to spare the trust from the potential ravages of an extended bear market. A smoothing rule is mandatory in most (if not all) New York model/4 percent statutes. The three year smoothing rule is available, in the trustee’s discretion, under the Delaware model. See Prop. N.C.G.S. § 37A-1-104.4(a).

Mechanics of Conversion

Prop. N.C.G.S. section 37A-1-104.2 provides that a trustee (other than an Interested Trustee) may elect to convert an income rule trust to a unitrust (or vice versa) or change the unitrust percentage if (1) the trustee adopts a written policy involving the proposed action, (2) the trustee sends written notice of her intentions, together with the written policy, to the grantor (if living), all current beneficiaries and all beneficiaries “who would receive principal of the trust if the trust were to terminate at the time of the giving of such notice” and any trust advisors. If none of the foregoing beneficiaries object within 60 days of the receipt of notice, the trustee is free to take the proposed action without any court intervention. If there is no trustee other than an Interested Trustee, the trustee (or a majority of the trustees if there are multiple trustees) may without court approval propose to convert to a unitrust (or vice versa) by taking the same actions discussed above with the addition of appointing a Disinterested Person who, acting in a fiduciary capacity, determines the unitrust percentage. An “Interested Trustee” is a trustee to whom income or principal could currently be distributed, or who could be replaced by a beneficiary who has a current income or principal distribution right, or a trustee with a support obligation to a beneficiary if distributions could be used to satisfy those legal obligations. An interesting query: Could the provisions of N.C.G.S. section 32-34 (prohibiting a fiduciary from exercising on her own behalf what would otherwise be a general power of appointment), in some situations, convert what would otherwise be an Interested Trustee into a Disinterested Trustee?

Prop. N.C.G.S. section 37A-1-104.3(a) provides a safe shelter for the timid trustee. Rather than exercising discretion to make a unitrust conversion, a trustee may petition Superior Court for an order “the Trustee deems appropriate.” Under subsection (b), a beneficiary may request a trustee to either convert to a unitrust (or vice versa) or change the unitrust percentage. If the trustee fails to take the action, the beneficiary may petition the Superior Court to order the trustee to take the action. Subsection (c) says that “[a]ll proceedings under this Section shall be conducted as provided in G.S. 37A-1-105.”

Under Prop. N.C.G.S. section 37A-1-105(a), as discussed above, a court will not interfere with the trustee’s decision absent an abuse of discretion. Further, under subsection (d) a trustee may petition the court to determine whether her proposed action will result in an abuse of discretion. If the trustee’s petition adequately describes the proposed action, explains the underlying rationale for the action and explains how the various beneficiaries will be affected by the proposed action, a challenging beneficiary must meet the burden of establishing that the proposed action will be an abuse of discretion.

Under the foregoing procedures of the Proposed Legislation, apparently if a trustee would rather not exercise the discretion to convert to a unitrust (perhaps she believes it will be inviting litigation, not withstanding the very high burdens that a challenging beneficiary must meet), or if the beneficiaries object, the court will proceed under Prop. N.C.G.S. section 37A-1-105. On the other hand, if a current beneficiary wishes to force a conversion to a unitrust because the trust has not generated a 3 percent income return, either because the trustee refuses to exercise her power of equitable adjustment or because of other breaches of the Prudent Investor Act (perhaps lack of diversification or demonstrated partiality towards remainder beneficiaries), the current beneficiary should not have a difficult time proving up an abuse of discretion under Prop. N.C.G.S. section 37A-1-105. Presumably remedies would remain available under general fiduciary standards and under the Prudent Investor Act.

Tax Issues

As discussed above, both the equitable powers of adjustment and the use of unitrusts present significant tax issues, many of which either could be avoided through careful drafting or would lurk as silent traps for the blissfully unwary.

For once, however, the Internal Revenue Service may be coming to the rescue. Aware of modern portfolio theory, the Restatement (Third) of Trusts, the Uniform Prudent Investor Act reliance on total return investing, the growing interest in unitrusts and the popularity of the Uniform Principal and Income Act of 1997 with its equitable power of adjustment, the Service issued proposed regulations on Feb. 15, 2001, blessing what it perhaps viewed as the inevitable. The regulations, when final, will certainly facilitate the exercise of powers of adjustment, the design of unitrusts and the conversion of existing trusts to unitrusts. In fact, the proposed regulations were issued over five months before Delaware enacted the first unitrust statute on June 21, 2001. Although the regulations remain “proposed” and were to have been finalized by the end of 2002, Bradford Poston, a key developer of the proposed regulations, has given emphatic assurances that the regulations are moving quickly through multiple divisions of the Service and will be finalized no later than June 30, 2003. Telephone Interview with Bradford Poston, Attorney Advisor, Office of Chief Counsel, Internal Revenue Service (Dec. 17, 2002).

Perhaps the most important provision of the proposed regulations is a re-definition of income under Code section 643(b). The new definition of income states:

For purposes of subparts A through D, part I, Subchapter J, Chapter 1 of the Internal Revenue Code, income, when not proceeded by the words “taxable”, “distributable net”, “undistributed net”, or “gross”, means the amount of income of an estate or trust for the taxable year determined under the terms of the governing instrument and applicable local law. Trust provisions that depart fundamentally from traditional principles of income and principal, that is, allocating ordinary income to income and capital gains to principal, will generally not be recognized. However, amounts allocated between income and principal pursuant to applicable local law will be respected if local law provides for a reasonable apportionment between the income and remainder beneficiaries of the total return of the trust for the year, including ordinary income, capital gains, and appreciation. For example, a state law that provides for the income beneficiary to receive each year a unitrust amount of between three percent and five percent of the annual fair market value of the trust assets is a reasonable apportionment of the total return of the trust. Similarly, a state law that permits the trustee to make equitable adjustments between income and principal to fulfill the trustee’s duty of impartiality between the income and remainder beneficiaries is generally a reasonable apportionment of the total return of the trust. These adjustments are permitted when the trustee invests and manages the trust assets under the state’s prudent investor standard, the trust describes the amount that shall or must be distributed to a beneficiary by referring to the trust’s income, and the trustee after applying the state’s statutory rules regarding allocation of income and principal is unable to administer the trust impartially. In addition, an allocation of capital gains to income will be respected if the allocation is made either pursuant to the terms of the governing instrument and local law or pursuant to a reasonable and consistent exercise of a discretionary power granted to the fiduciary by local law or by the governing instrument, if not inconsistent with local law.

Prop. Reg. § 1.643(b)-1. Obviously, the new definition is significant because it sanctions both the power to adjust and unitrust payouts if “applicable local law” provides for apportionment between principal and income through a power to adjust or unitrust provisions. Note that the conditions for exercising the power to adjust track RUPIA section 104 and Prop. N.C.G.S. section 37A-1-104(a). The regulations then apply the new definition in the context of marital deductions, GST grandfathering and definitions of distributable net income.

Marital deduction Issues. In the marital deduction context, both the power of appointment trust under Code section 2056(b)(5) and the QTIP provisions under Code section 2056(b)(7) require the annual distribution of all income to the surviving spouse to qualify for the estate tax marital deduction; similarly an inter vivos power of appointment trust requires distribution of income to the spouse to qualify for the gift tax deduction under Code section 2523(e). Without regulatory reform of the definition of “income”, exercise of a power to adjust or conversion to a unitrust could result in withholding income from the surviving spouse or be viewed as a prohibited power of appointment under the QTIP rules. Of course, the careful and knowledgeable planner could draft a marital trust containing a power of adjustment or a unitrust payout as long as language providing that the greater of trust income (under traditional definitions of income) or, as the case may be, the adjusted or unitrust amount was distributed. The proposed regulations redefine income, for these purposes, by reference to proposed Treasury Regulations section 1.643(b)-1. Prop. Reg. §§ 20.2056(b)-5(f)(1), -7(d)(1), 20.2523(e)-1(f)(1).

GST Grandfathering Issues. Irrevocable trusts settled before Sept. 25, 1985, and testamentary trusts under instruments executed before Oct. 22, 1986, with respect to decedents dying before Jan. 1, 1987, are exempt from generation skipping transfer taxation. Treas. Reg. § 26.2601-1(b). The exemption may easily be lost by alterations to the terms of the trust or additions of additional property to the trust. However, the power of a GST grandfathered trust to accumulate income is not a constructive addition unless the power to accumulate income is enhanced (or a new power is added). Treas. Reg. § 26.2601-1(b)(1)(vi), (b)(4)(i)(D). Obviously, powers of adjustment or conversions to unitrusts pose issues of possible accumulations of income or constructive additions. The proposed regulations specify that if pursuant to state law a trustee elects to exercise a power of adjustment or the trust is converted to a unitrust payout there will not be an impermissible enhancement of an existing power to accumulate or the addition of a power to accumulate income for the benefit of skip beneficiaries. Prop. Reg. § 26.2601-1(b)(4)(i)(D)(2), (E).

DNI Issues. The most profound change advanced by the proposed regulations involves the potential inclusion of capital gains in distributable net income under Code section 643(a). The interplay between the proposed regulations, the terms of governing instruments and state law is at best tricky and merit careful practitioner attention. Unfortunately, the proposed regulations, carefully read in conjunction with the preambles, are not a model of clarity. It is important to bear in mind that Code section 643 is a definitional section. As discussed above, Code section 643(b) provides the definition of “income” when not preceded by various adjectives (including “distributable net”). As discussed, the proposed regulations under Code section 643(b) are significant because proposed regulations applicable to the marital deduction rules and rules applicable to GST exempt trusts reference the proposed rules under Code section 643(b) and allow total return concepts to be applied to marital trusts and GST exempt trusts.

What is “respected” for Code section 643(b) purposes (complying with martial deductions rules, for example) does not necessarily mean that an item of 643(b) income will be included in distributable net income under Code section 643(a), however. Although the last sentence of proposed Treasury Regulation section 1.643(b)-1 and proposed Treasury Regulation section 1.643(a)-3(b) (which provides new rules for determining when capital gains will be includable in distributable net income) provide that allocations of capital gains to income will be respected if the allocations are “pursuant to the terms of the governing instrument and applicable local law, or pursuant to a reasonable and consistent exercise of discretion by the fiduciary (in accordance with a power granted to the fiduciary by local law or by the governing instrument, if not inconsistent with local law) . . . ” the similarity stops there. To fully move capital gains into DNI, the fiduciary must make the allocation pursuant to the foregoing standards and (1) allocate the capital gains to income, (2) allocate the capital gain to corpus but treat it on the books, records and tax returns as part of a distribution, or (3) allocate the gain to corpus but utilize it in determining the amount which will be distributed to a beneficiary. Prop. Reg. § 1-643(a)-3(b).

To make the allocation of capital gains to DNI, the fiduciary must derive her authority from either “the terms of the governing instrument and applicable law” (query whether that means applicable law must affirmatively grant the authority or whether the authority is merely allowable under local law), or by the exercise of “reasonable and consistent” discretion granted by “local law or by the governing instrument.” Pursuant to the foregoing, a provision in the governing instrument or applicable statute can direct distributions to be treated as coming from realized gains to the extent those gains exceed ordinary income. Absent specific provisions in the instrument and state law, the trustee is put to an irrevocable election (the regulation requires her to be “consistent”). Once she has elected to treat capital gains as either distributions of principal or distributions of gains includable in DNI, she will be locked into that election for (presumably) the remainder of the trust term (a “consistent” exercise of discretion).

A critical consideration for the trustee working with the Proposed Legislation (or similar legislation in another state) and the proposed Treasury regulations is, notwithstanding a unitrust distribution (or for that matter a distribution subsequent to a power to adjust) that includes capital gains, whether the gains will be taxed at the trust level under traditional taxation approaches, or included in DNI and taxed to the beneficiary. Proposed Treasury regulations make the inclusion of capital gains in DNI much easier than under current Treasury Regulation section 1.643(a)-3(a) (where it is possible, but difficult). Prop. N.C.G.S. section 37A-1-104.4(d)(2) gives the trustee the discretion to allocate net short term, and then net long term, capital gains to income. In view of the proposed Treasury regulations and the idea that capital gains need no longer be “trapped” at the trust level, it may be tempting to assume that inclusion of gains in DNI is an always to-be-desired result. U.S. Trust Company recently published a thoughtful discussion of the topic and cautioned against a rush to inclusion of capital gains in DNI. U.S. Trust, Practical Drafting at 6918-25. The article makes sound arguments, backed with data, that tax neutrality between the income beneficiaries and the remainder beneficiaries is enhanced (and a lower payout justified) by continuing to tax gains at the trust level. Id. Both U.S. Trust, Practical Drafting and Wolf’s Real property & Trust Law Journal article are excellent resources and recommended reading for an in depth treatment of this subject.

Summary

A massive nationwide shift in trust law is underway. In response to market shifts towards capital appreciation and away from traditional notions of income, modern portfolio theories are mandating new ways of thinking with regard to a trustee’s duties of impartiality as between different classes of beneficiaries while investing for total return. The legislative shift began with the Prudent Investor Act, and North Carolina joined that movement. The shift continues in legislatures across the nation with adoption of the Uniform Principal and Income Act of 1997 and other forms of total return legislation, joined by the Internal Revenue Service with regulations designed to work with those new laws. The General Assembly has an opportunity to assure that North Carolina remains with the modern trend . . . or is left behind as one of the very few states to have not responded to that trend.

Filed Under: Tax Issues, Trusts generally Tagged With: , , ,

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Updated October 2011

Medigap insurance supplements Medicare’s benefits, which is why it is also called Medicare supplemental insurance. Both federal and state laws regulate Medigap coverage. A policy must be clearly identified as Medicare supplemental insurance and it must provide specific benefits that help fill the gaps in your Medicare coverage. Other kinds of insurance may help you with out-of-pocket health care costs, but they do not qualify as Medigap plans.

Standard Medigap Plans

There are now ten standard Medicare supplement insurance plans that help pay some of your costs in the original Medicare plan and for some care it doesn’t cover.

Each one of the standard Medicare Supplement insurance plans, labeled A through N (I know, I know . . . I said there are ten plans and A through N equals 14 letters . . . there are no longer E, H, I and J plans), offers a different set of benefits, fills different “gaps” in Medicare coverage, and varies in price. Some insurance companies offer a “high deductible option” on Medicare supplement insurance Plans F, and higher coinsurance amounts for some services in Plans K and L. All Medicare supplement insurance Plans must cover certain basic benefits. (Plans K and L are recent additions and very few supplemental Medicare insurers are offering those plans). Current Medicare rates are also posted elsewhere on this site.

  • Basic Benefits
    • Covered by Medicare Supplement Insurance Plans A-N
  • Medicare Part A Hospital Deductible
    • $1,132 in 2011 for each benefit period for hospital service
    • Covered by Medicare Supplement Insurance Plans B-G and Plan N (Plans K and M cover 50% and Plan L covers 75%)
  • Skilled Nursing Home Costs
    • Your cost ($141.50 in 2011) for days 21-100 in a skilled nursing home
    • Covered by Medicare Supplement Insurance Plans C-G, M and N (plan K covers 50% and Plan L 75%)
  • Medicare Part B Deductible
    • Yearly deductible for doctor services ($162 in 2011)
    • Covered by Medicare Supplement Insurance Plans C and F
  • Medicare Part B Coinsurance
    • Generally 20% of services
    • All Plans (Plan K 50% – Plan L 75% – Plan N $20 office visits $50 ER visits)
  • Medicare Part B Excess Charges
    • The difference between your doctor’s charge and the Medicare approved amount, if your doctor does not accept assignment.
    • Covered by Medicare Supplement Insurance Plans F (100%) and G (80%)
  • Foreign Travel Emergency
    • 80% of the cost of emergency care outside the U.S.
    • Up to $50,000 in your lifetime
    • You pay a yearly deductible of $250
    • Covered by Medicare Supplemental Insurance Plans C-G, M and N

* If you choose the “high deductible option” on Medicare supplement plans F, you will first have to pay a $2,000 before the plan pays anything. This amount can go up every year. High deductible option policies often cost less, but if you get sick, your costs will be higher.

*Plans K and L provide for different cost-sharing for items and services than Plans A through J. Once you reach the annual limit ($4,640 for Plan K and $2,320 for Plan L), the plans pay 100% of the Medicare co-payments, coinsurance, and deductibles for the rest of the calendar year. The out-of-pocket annual limit does NOT include charges from your provider that exceed Medicare-approved amounts, called “Excess Charges.” You will be responsible for paying excess charges. the out-of-pocket annual limit will increase each year for inflation.

Insurance companies must use the same format, language and definitions when describing the benefits of each of the Medigap plans. They also must use a uniform chart (similar to the chart posted with this article) and outline of coverage to summarize the benefits. The idea is to make it easier for consumers to compare policies. As you shop for a Medigap policy, keep in mind that each company’s products are alike, so they are competing on service, reliability and price. Talk to your friends, neighbors, doctor and others who may have experience and an opinion.

Unlike some types of health coverage that restrict where and from whom you can receive care, Medigap policies generally pay the same supplemental benefits regardless of your choice of health care provider. If Medicare pays for a service, wherever provided, the standard Medigap policy must pay its regular share of benefits.

Medigap Premiums

Although the benefits are identical for all Medigap plans of the same type, the premiums may vary greatly from one company to another and from area to area. Insurance companies use three different methods to calculate premiums: issue age, attained age and no age rating.

If your company uses the issue age method, and you were 65 when you bought the policy, you will always pay the same premium the company charges people who are 65 regardless of your age. If it uses the attained age method, the premium is based on your current age and will increase as your grow older. Under the no age rating, everyone pays the same premium regardless of age. Your state insurance department must approve the rates charged for all Medigap policies. The insurance company can raise your premiums only when it has approval to raise the premiums for everyone else with the same policy.

Medicare SELECT

Another Medicare supplemental health insurance product called “Medicare SELECT,” is permitted to be sold by insurance companies or managed care plans throughout the country. Medicare SELECT is the same as standard Medigap insurance in nearly all respects. If you buy a Medicare SELECT policy, you are buying one of the standard Medigap plans. The only difference between Medicare SELECT and standard Medigap insurance is that each insurer has specific hospitals, and in some cases specific doctors, that you must use, except in an emergency, in order to be eligible for full benefits. Medicare SELECT policies generally have lower premiums because of this requirement.

When you go to the insurer’s “preferred providers,” Medicare pays its share of the approved charges and the insurer is responsible for the full supplemental benefits provided for in the policy. In general, Medicare SELECT policies are not required to pay any benefits if you do not use a preferred provider for non-emergency services. Medicare, however, will still pay its share of approved charges regardless of the provider you choose.

Medicare SELECT is authorized for sale until at least June 1998. At that time, if you have a Medicare SELECT policy, you will be able to either keep the SELECT policy with no changes in benefits or regardless of the status of your health, purchase another Medigap policy offered by the insurer, if the insurer issues Medigap insurance other than Medicare SELECT. To the extent possible, the replacement would have to provide similar benefits.

Open Enrollment Guarantees Your Right To Medigap Coverage

State and federal laws guarantee that for the first 6 months after the date you are both enrolled in Medicare Part B and age 65 or older, you have a right to buy the Medigap policy of your choice regardless of any health problems you may have. If, however, your birthday falls on the first day of the month, your Part B coverage (if you buy it) begins on the first day of the previous month, while you are still 64. Your Medigap open enrollment period would also begin at that time.

During this 6-month open enrollment period, you can buy any Medigap policy sold by any insurer doing Medigap business in your state. The company cannot deny or condition the issuance or effectiveness, or discriminate in the pricing of a policy because of your medical history, health status or claims experience. The company can, however, impose the same preexisting condition restrictions that apply to Medigap policies sold outside the open enrollment period. Preexisting conditions are generally health problems for which you saw a doctor within the 6 months before the date that the policy went into effect. Your Medicare card shows the effective dates for your Part A and/ or Part B coverage. To figure whether you are in your Medigap open enrollment period, add 6 months to the effective date of your Part B coverage. If the date is in the future and you are at least 65, you are eligible for open enrollment. If the date is in the past, you are generally not eligible. (If you were entitled to Medicare before age 65, see the following section on open enrollment and persons with disabilities.)

If you are covered under an employer group health plan when you become eligible for Part B at age 65, carefully consider your options. Once you enroll in Part B, the 6-month Medigap open enrollment period starts and cannot be extended or repeated.

If you are covered under an employer plan that is primary to Medicare in paying your medical bills, you will not need a Medigap plan until you are no longer covered under the employer plan. If you begin buying Part B as a supplement to your employer plan while it is the primary payer, you will start your Medigap open enrollment period when it is of little use to you.

You may, therefore, want to wait to buy Part B until you are ready to make optimum use of your Medigap open enrollment period. Also keep in mind that if you have already triggered your Medigap open enrollment period at age 65, you cannot get another one by dropping Part B and re-enrolling during a special enrollment period after you are no longer covered under the employer plan.

Medigap Open Enrollment and the Persons With Disabilities

If you become eligible for Part B benefits before age 65 because of a disability or permanent kidney failure, federal law guarantees you access to the Medigap policy of your choice when you reach age 65. During the first 6 months you are age 65 and enrolled in Part B, you can buy the policy of your choice regardless of whether you had enrolled in Part B before you were 65.

During these 6 months, you cannot be refused a policy because of your disability or for other health reasons. Moreover, you cannot be charged more than other applicants, which can greatly reduce the amount you are paying. A waiting period of up to 6 months, however, may be imposed for coverage of a pre-existing condition.

Several states go beyond federal law and require at least a limited open enrollment for Part B beneficiaries under 65. Check to see whether your state does. In addition to any state requirement, federal law requires that you be given an open enrollment opportunity when you turn 65, even if you were previously entitled to open enrollment under state law.

Guaranteed Renewable

All standard Medigap policies are guaranteed renewable. This means that the insurance company cannot refuse to renew your policy unless you do not pay the premiums or you made material misrepresentations on the application. Older Medigap policies (sold before 1992) may allow the company to refuse to renew on an individual basis. These older policies provide the least permanent coverage.

Older Medigap Policies

Many federal requirements do not apply to Medigap policies sold before 1992, when Medigap was standardized. There is generally no requirement that you switch to one of the standard plans if you have an older policy. However, you may be required to switch if your older plan was not guaranteed renewable and the company discontinues the type of policy you have. Check with your state insurance department to find out what state-specific requirements are in force.

Switching Medigap Policies

Even if you are not required to convert an older policy, you may want to consider switching to one of the standardized Medigap plans if it is to your advantage and an insurer is willing to sell you one. If you do switch, you will not be allowed to go back to the old policy. Before switching, compare benefits and premiums, and determine if there are waiting periods for any of the benefits in the new policy. Some of the older policies may provide better coverage, especially for prescription drugs and extended skilled nursing care. On the other hand, older Medigap polices, which cannot be sold to new applicants, may experience greater premium increases than newer standardized policies that can enroll new applicants (younger, healthier policyholders whose better claims experience will help to moderate premiums).

If you have had a Medigap policy for at least 6 months and you decide to switch, the replacement policy generally cannot impose a waiting period for a preexisting condition. If, however, a benefit is included in the new policy that was not in the old policy, a waiting period of up to 6 months–unless prohibited by your state–may be applied to that particular benefit.

You do not need more than one Medigap policy. If you already have a Medigap policy, you must sign a statement when you buy another indicating that you intend to replace your current policy and will not keep both policies. However, do not cancel the old policy until the new one is in force and you have decided to keep it.

Use the “Free-Look” Provision

Insurance companies must give you at least 30 days to review a Medigap policy. If you decide you don’t want the policy, send it back to the agent or company within 30 days of receiving it and ask for a refund of all premiums you paid. Contact your state insurance department if you have a problem getting a refund.

Carrier Filing of Medigap Claims

Under certain circumstances, when you receive medical services covered by both Medicare and your Medigap insurance, you may not have to file a separate claim with your Medigap insurer in order to have payment made directly to your doctor or medical supplier.

By law, the Medicare carrier that processes Medicare claims for your area must send your claim to the Medigap insurer for payment when the following three conditions are met for a Medicare Part B claim:

  • Your doctor or supplier must have signed a participation agreement with Medicare to accept assignment of Medicare claims for all patients who are Medicare beneficiaries;
  • Your policy must be a Medigap policy; and
  • You must instruct your doctor to indicate on the Medicare claim form that you wish payment of Medigap benefits to be made to the participating doctor or supplier. Your doctor will put your Medigap policy number on the Medicare claim form.

When these conditions are met, the Medicare Carrier will process the Medicare claim, send the claim to the Medigap insurer and generally send you an Explanation of Medicare Benefits (EOMB) or Medicare Summary Notice (MSN). Your Medigap insurer will pay benefits directly to your doctor or medical supplier and send you a notice that it has done so.

Filed Under: Medicare Tagged With: , , ,