You now understand the basics of annuities because you read Banish Annuity Confusion in 5 Minutes (If you haven’t read it and you aren’t an annuity expert, you better go back and read it now). But how can annuities help (or hurt!) you when considering either Medicaid or VA benefits? Let’s take Medicaid here . . . and next time we’ll look at VA benefits and annuities.

WARNING: This article will not be the easiest to read. I’m sorry. If you can’t sleep, keep this handy and it’ll do the trick. Take your time and do your best. And, of course, I’ll answer questions if you post them in the “Comments” area below.

Also, if some of the basic Medicaid concepts (like “countable versus noncountable” and “sanctionable transfers”) present a challenge, take a look at NC Nursing Home Medicaid Law Explained on this site. There is a good table of contents that is hot-linked to various topics.

Here We Go . . .

If properly annuitized, an otherwise countable asset for Medicaid purposes can become a noncountable asset. If the asset is sufficiently liquid (a farm is not “liquid” but cash is) it can be annuitized (OK . . . made into an annuity), and if properly structured the annuity will not be countable.

Caution: Most annuities sold on the open market are countable! To be “noncountable” an annuity must meet each of the following requirements:

• *  The annuity must be irrevocable and nonassignable,
• *  The annuity must have a fixed (or regular) income stream of equal payments,
• *  The annuity cannot extend beyond the actuarial life expectancy of the annuitant (using approved life expectancy tables), and
• *  The annuity must name the State as the remainder beneficiary.

One exception to the last requirement is that a spouse or a minor or disabled child may be named in first position ahead of the state.

What About An Annuity IN An IRA?

It depends . . .

IRA belonging to Institutionalized Spouse. If the IRA belongs to the institutionalized spouse, the IRA can be made noncountable but the income stream that it will throw off by being annuitized will be countable income to the institutionalized spouse and treated the same as any other income. If the income isn’t too high, the additional income may not provide any problem at all, but if the additional income causes the institutionalized spouse’s income to rise too high, there could be problems with qualifying for nursing home Medicaid.

Because an institutionalized spouse may never have more than $2,000 in noncountable assets, many people are tempted to immediately cash in the institutionalized spouse’s IRA and transfer the proceeds to the community spouse in a nonsanctioned transfer. The problem with that is depending upon the size of the cashed-in IRA there could be a hefty tax penalty because all of the IRA will be includable in gross income that year. Annuitizing the institutionalized spouse’s IRA provides an alternative to simply cashing in the IRA. If a nursing home stay is anticipated in the next few years, sometimes it may be a good idea to begin cashing in the IRA over a number of years to minimize the tax impact.

IRA belonging to the Community Spouse. If a particular state does not outright exempt a community spouse IRA (Georgia does, but North Carolina does not), then she could simply annuitize her IRA (according to the rules discussed above) and exempt the IRA.

What About An Annuity That Is NOT In An IRA?

There are strategies that may be pursued involving annuities that do not have anything to do with IRAs. A plain, “non-IRA” annuity structured to comply with the rules discussed above can be a convenient way of converting countable cash into a noncountable asset.

Annuities and a Single Guy. With this particular strategy assume that a single individual is a nursing home resident who is attempting to qualify for Medicaid. For this strategy bear in mind two rules. First, when the state files a Medicaid estate recovery claim, it will seek reimbursement only for what it actually paid out in Medicaid benefits. Second, the state Medicaid program will never pay as much per month to the nursing home as a private pay patient would pay. If you plan on an intentional estate recovery claim the amount recovered by the state will always be less than the amount that a private pay patient would have paid had she not qualified for Medicaid.

Take for example 70-year-old Ward Cleaver (yes, yes, I loved “Leave it to Beaver”), who has $200,000 cash and a $250,000 residence. In addition to his assets he has monthly social security income of $1,000. A nearby nursing home has a private pay rate of $6,000 a month, but a state Medicaid reimbursement rate of $4,500 a month. Ward has a life expectancy of 13.55 years. Ward uses his $200,000 cash to purchase a 10 year Medicaid compliant annuity that will pay approximately $2,000 a month. He will have converted the $200,000 countable cash assets into a noncountable annuity. With the annuity payments his monthly income will be $3,000 monthly. Now that Ward qualifies for Medicaid his income will be applied to the nursing home bill and the state Medicaid program will pay the $1,500 difference. In this example, assume that Ward dies after 48 months in the nursing home. In four years the remaining balance in Ward’s annuity should be approximately $100,000. In that 48 month period the state has paid $72,000 in benefits that will be subject to an estate recovery claim. If the state claims $72,000 of Ward’s remaining $100,000 annuity there will be a balance of $28,000. That amount will go to the other remainder beneficiaries of the annuity.

If Ward did not purchase an annuity his $200,000 cash would have been gone in 40 months because the private pay rate for the nursing home was $6,000. His income was simply $1,000 and he would have had to pay $5,000 monthly to make up the difference. If Ward’s $200,000 was gone in 40 months and he died after month 48, the state Medicaid program would have had benefit payments for 8 months. The state would have paid $3,500 a month because that was the difference between Ward’s $1,000 monthly income and the monthly Medicaid reimbursement rate of $4,500 for the nursing home. In other words, over 8 months Medicaid would have paid $28,000. In this particular case the entire $200,000 would be gone in 40 months, the state would pay out an additional $28,000 and have an estate recovery claim for that amount on Ward’s death (which they would collect against the house). Without an annuity the out of pocket cost of the family was $228,000. By purchasing an annuity the family saved $56,000.

A Slight Change of Facts. Assume here that Ward lived his entire life expectancy of 13.55 years (which is about 163 months). Let’s also assume that in that period of time his home appreciated in value to $350,000. If Ward does not purchase an annuity his cash will be gone in 40 months as explained above. If he goes on Medicaid after month 40 and lives another 123 months (that’s 40 months plus 123 = 163) Medicaid will pay out $430,500 which will be the subject of an estate recovery claim.

On the other hand, had Ward purchased an annuity the results, although not particularly impressive, would have been somewhat better (after all, we are simply trying to illustrate a concept here!). With a 10 year annuity paying $2,000 monthly, combined with Ward’s social security benefits of $1,000 monthly, the Medicaid program would pay $1,500 monthly. Over that 10 year period, Medicaid would pay $180,000. At the conclusion of month 120 Ward’s annuity will be exhausted which would leave another 43 months until Ward died at month 163. During that additional 43 months Medicaid would pay $3,500 monthly (the difference between the nursing home reimbursement rate of $4,500 and Ward’s social security of $1,000). Therefore during the remaining 43 months Medicaid would pay another $150,500. The total Medicaid had paid by Ward’s death would be $335,500. That amount would be the subject of an estate recovery claim against Ward’s home. In this case we said the home had appreciated in value to $350,000 (after all we wanted to make this example work for you!). In that case there would be almost $20,000 of equity left in the home to pass to the family.

Annuities for the Married Couple. When dealing with a married couple, annuities open up a completely new and attractive strategy. Let’s use the Ward Cleaver facts but assume that Ward is married to June.

If Ward and June live in a state (like Georgia) in which June is allowed to keep the maximum community spouse resource allowance of $113,640 and Ward is allowed to keep a maximum countable asset level for an individual of $2,000, Ward and June will have a spend down of approximately $90,000 (the amount of their $200,000 cash that they would need to spend down to get to acceptable Medicaid levels).

If Ward and June live in a state (like North Carolina) in which June is allowed to keep only half the countable assets (but in no event more than $113,640) and Ward is allowed to keep up to $2,000 then Ward and June will need to spend down approximately $100,000. (I said approximately to keep it easy . . . I promise someone will say to me, “Bob, your numbers don’t add up!”)

If June took $100,000 and purchased in her name a Medicaid compliant annuity (compliant with the four requirements outlined above) she would have a noncountable annuity and Ward would qualify for Medicaid. Bear in mind that there is no requirement (in all but four states) that the annuity extend to the complete life expectancy of the annuitant. In other words, the annuity could be much shorter.

If June purchased a 10 month annuity with the $100,000 that paid $10,000 monthly she would have a complete return of the amount invested in the annuity by the end of that nine month period. Recall also that while the annuity payments would count as income to June (for Medicaid purposes) during that 10 month term, the community spouse’s income has no bearing on whether the institutionalized spouse continued to qualify for Medicaid. At the end of ten months June is in the financial position she was in before Ward went into the nursing home.

Point to ponder: Timing is everything in the foregoing strategy. If the annuity is purchased too soon and the first annuity payment of $10,000 arrives before Ward is in the nursing home or Ward has been determined to be qualified for Medicaid, the first annuity payment of $10,000 will put Ward and June, once again, over the Medicaid asset threshold (they will be at slightly over $120,000). In this particular case they may wish to consider purchasing a slightly larger annuity (perhaps $110,000 or more) or be very careful that the annuity is purchased close to the time that the application has been submitted so that the first annuity payment will not arrive before Ward has been determined to be qualified for Medicaid.

Another point to ponder: The foregoing strategy does have a drawback. If the community spouse’s income was below the monthly maintenance needs allowance she would have received an allowance out of the institutionalized spouse’s income. The annuity payments, however, will almost certainly put the community spouse’s income over the minimum monthly maintenance needs allowance and she will not be entitled to any allowance from her spouse’s income during the term of the annuity. On the other hand, once the annuity has completed all payments the community spouse would be eligible to apply for the allowance from the institutionalized spouse’s income.

Another point to ponder: The foregoing income dilemma illustrates one good reason for attempting to purchase an annuity that is as short in term as possible (simply to “get the annuity payments over with”). Also recall that a Medicaid qualified annuity must name the state Medicaid program as the remainder beneficiary (which could be in second position behind a surviving spouse) in order to qualify. If the community spouse dies during the term of the annuity the remaining amount will go to the institutionalized spouse and disqualify him for Medicaid. That is yet another good reason for a short term annuity combined with instructions to the community spouse to remain alive during the term of the annuity (relax, this was our stab at a bit of humor!).

A Note on Medicaid Compliant Annuities. There are hundreds of fine annuity providers in the United States. Nevertheless, most of those providers do not offer extremely short term annuities. In fact, finding a well-known annuity provider that will issue an annuity shorter than 36 months is extremely difficult. There are, however, specialty annuity providers that issue extremely short term annuities. These companies market their services to elder law attorneys. Accordingly, a competent elder law attorney will be able to refer you to one of these companies.

Finally . . . structuring any of these transactions is quite tricky . . . you really shouldn’t try this alone. Get help.

Congratulations! You made it. Next we’ll discuss annuities and VA benefits.