Using an Annuity to Play the Medicaid Game

This week, Gail explains how an annuity can help elderly parents qualify for Medicaid and preserve assets for their heirs.

Dear Gail,

My dad is in his late 80's and is finally coming to the realization that he's not going to be able to live on his own any more. He'll probably be in a nursing home before the end of this year. My mom had to enter a nursing home five years ago because my dad — who had taken care of her for nearly 10 years — was not strong enough to continue doing so. So I'll soon have both parents in nursing homes, and perhaps not even the same one.

My parents aren't wealthy and neither am I or my three siblings. Medicaid is paying for my mom's care. My dad's going to need financial help, too. Our question is this: if he sells their home and uses the money — about $160,000— to buy an immediate annuity, will this hurt his Medicaid eligibility?



Dear Daniel,

While all of us want our parents around us for as long as possible, somehow we don't picture them growing frail. In our minds they will always be the same strong adult figures they were when we were children. I can personally attest that It can be painful to see age take its toll. If we're fortunate enough to have our mom or dad — or both — live to an exceptional age, at some point there is a role reversal. Suddenly we are the ones doing the parenting. As tough as it is, you're a good son for taking on part of this responsibility.

Let me start with a brief primer on how annuities work. At its most basic, an annuity is a stream of income guaranteed by an insurance company. In exchange for a sum of money, the insurer promises to pay you a certain amount of income for a specified period of time. If you choose the "life" option, the income must continue as long as the annuitant (your dad, in this case) lives. When the annuitant dies, the income stops.

Most annuities also give you the choice to receive income for a specific length of time, such as 10, 15, or 20 years. In this case, if the annuitant dies before the term is up, the payments continue to be paid to his beneficiary.

As the name implies, a "deferred" annuity is one where the investment is made today, but the income payments are postponed until some future date. Since you don't pay income tax on any gains your annuity investment may earn until you withdraw the money, this approach gives your original investment time to increase in value. At some point in the future, when you decide you need the income, hopefully the annuity will be worth more and would consequently generate more income than your original investment would have.

In contrast, with an "immediate" annuity, the option you are considering for your dad, you invest a sum of money and start receiving income from it right away. There is no waiting period.

Without going into too many details, you should know that the income an annuity pays will either be a "fixed" amount that never changes, or an income stream which varies somewhat, depending upon the performance of the investments owned inside the annuity. The latter type is called (surprise) a "variable" annuity.

You should also know that annuities have insurance related fees and charges and are offered by contract only. The contract will be between the owner and the insurance company. All insurance companies impose a fee known as a "surrender charge" if you cancel the contract before a minimum number of years have elapsed. Though not applicable in your dad's case, Daniel, the IRS hits an annuity owner with a 10-percent penalty if he makes any withdrawals before age 59 1/2. That's because in the eyes of Congress, annuities are considered retirement vehicles. (There are some exceptions to the early withdrawal penalty, so consider seeing a financial advisor if you need to tap an annuity before you reach this age. If you're adventurous, head to an internet site that contains the Internal Revenue Code and look up "Section 72(q)." )

My point is, Daniel, read the fine print before your dad signs on the dotted line so you know exactly what he's getting into. Remember, the income promised depends upon the financial strength of the insurance company you use, so ask how it is rated. (I recommend going with an insurer that at least has an "A" or better rating.)

Now for the "Medicaid" part of your question.

Despite their similar names, Medicaid and Medicare are two completely separate — and very different — programs. Medicare provides certain health benefits only to Americans who are at least 65 years old. It is completely administered by the federal government. Many people mistakenly believe that Medicare will cover their nursing home costs. This is not true. Medicare only picks up full-service nursing home care if it is required immediately after a senior citizen comes out of the hospital. And only for a limited period of time.

On the other hand, Medicaid is a health-care assistance program with money coming both from the federal government and each state. However, the federal government the states a great deal of leeway in how they run their own Medicaid programs. Medicaid payments can be used to cover the cost of nursing home care.

Age has nothing to do with whether you qualify or not. Instead, each state, within broad federal guidelines, sets its own eligibility requirements. There are limits on the maximum amount of income you can have, the amount of assets you're allowed to keep, and so forth. In addition, Medicaid has a three-year "look-back" to prevent people from giving away assets so they can meet the eligibility requirements just before they enter a nursing home.

If you have too many assets — investments, savings, and so forth- you are expected to use these to pay for your care until you "spend them down" to the maximum allowed. This can mean using up much of your life savings, leaving little for your heirs. To get around this, clever accountants and attorneys have devised a number of strategies.

For instance, according to Armond Budish, author of Avoiding the Medicaid Trap, back in the early 1990s "a few aggressive planners were buying fixed term annuities — with terms of 20 or 30 years — for clients in their nineties! Typically, a child was named as the beneficiary.

Here's the thinking behind this approach: Instead of spending all of dad's money to pay for his nursing home care, sell his investments and lock up the proceeds in an immediate annuity. Sure, he'll have to use the annuity income he receives to defray the cost of his care. But the longer the period of time over which the annuity must be paid, the smaller the payments. Since Medicaid picks up where your own ability to pay stops, the less income the patient has to
contribute toward the cost of his care, the more Medicaid covers. If dad dies two years later at age 93, instead of seeing a big chunk of her entire inheritance spent on dad's care, the daughter will receive annuity payments for the next 18 years.

Don't even think about trying this! Budish, an elder law attorney in the Cleveland, Ohio area and host of a popular Sunday morning talk show that focuses on senior citizen issues, says the government has since imposed strict rules on the length of the annuity term. These days it cannot exceed the actual amount of time the annuitant is expected to live (based on Medicaid's or the insurance company's life expectancy table). But, adding their own twist to this rule, Budish says, "A number of states now say you also have to consider the health of the person and not just use the life expectancy table." In other words, if the life expectancy of an 75-year-old is 9 years, but your dad is in an advanced stage of cancer, 2 years might be the acceptable term for his annuity.

As Budish told me, your dad's situation is really quite simple: Assuming he meets his state's Medicaid eligibility requirements, he will be expected to use whatever income his immediate annuity pays him - plus Social Security and any other income he receives, such as dividends — toward the cost of his nursing home care. The amount over and above this will be picked up by Medicaid. (Nursing homes that accept Medicaid must agree to limit the total amount they charge Medicaid patients.)

The real question is, why is your dad doing this at all? "I'm not sure what you're accomplishing," says Budish. If your dad wants to preserve some of his assets for you and your siblings, Budish suggests he simply give them to you. This will delay, but not prevent, his Medicaid eligibility.

For instance, say your dad took half of what he gets from the sale of his home — $80,000— and gives each of his four kids $20,000. Or maybe he uses it to fund 529 college savings accounts for his grandkids. On June 1st he applies for Medicaid.

Medicaid will require records for all of your dad's assets— bank accounts, brokerage statements, etc. — going back three years to June 1, 2000 to see where the money went. "If anything was transferred (given away) within this period," says Budish, "then they apply the formula." Using our example, here's how it works:

Divide the amount of money your dad gave away — $80,000— by the average monthly cost of nursing home care in your area. Let's assume this is $4,000. The result is "20." That's the number of months he has to wait before he is eligible for Medicaid. (Note, though, that the cost of nursing home care varies dramatically throughout the country — investigate the costs in your area before making any plans.)

But what's the big deal? Your dad still has $80,000 left, which means even that even if he didn't get a dime from Social Security or other sources, he'd still have enough to pay for those 20 months out of his own pocket.

In Budish's words, "If you can protect half the money, that's better than none." So consider a consultation with an elder attorney in your state to be sure your dad is making the right move for himself and your family.

Take care,


P.S. An annuity makes a lot more sense in the case of couple where only one spouse is in need of nursing home care. For instance, say the husband has to enter a nursing home, but the couple's assets exceed the amount they're allowed in order for him to qualify for Medicaid. In this case, says Budish, before he applies for Medicaid, "spend down" the couple's assets by buying an immediate annuity in the wife's name and have it paid out over her life expectancy, or sooner.

After that, the husband qualifies for Medicaid. The wife receives the annuity income, but isn't required to use her income to pay for the husband's nursing home care. If she doesn't need the income for expenses, she can re-accumulate the assets and potentially replace the amount spent to purchase the annuity.

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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.