There seems to be a lot of confusion about the use of annuities for Medicaid planning. There are many financial services companies out there offering all kinds of them. Recently there seems to be a big push in the marketplace for “Medicaid friendly annuities.” What are they and what makes them so “friendly”?
Before we can discuss “Medicaid friendly annuities”, we have to have a discussion about what are annuities. Although there are many different types and styles, most annuities fall into two general categories, immediate annuities and deferred annuities.
Immediate annuities were the original type, going back to ancient Roman times. These types of annuities provide you with a steady stream of income for a period of time. It is kind of like buying a pension. You give the annuity company a pile of cash, and they give you a monthly payment for a fixed period of time or for the rest of your life.
Immediate annuities are sometimes referred to as reverse life insurance. With life insurance, you pay monthly premiums to the insurance company and your beneficiaries get a lump sum at your death. With an immediate annuity, you pay a lump sum up-front to the annuity company, and they pay you a monthly benefit until death.
For centuries, immediate annuities were about the only type of annuities around and were used to provide a regular income for those who were no longer working or for the widows and orphans of wage earners. They were basically private pensions. Now immediate annuities only make up about 10% of all annuities sold. The bulk of the remainder of the annuities sold now are deferred annuities.
With a deferred annuity, you give the annuity company a lump sum and they invest it. Hopefully it grows. You then choose to make a withdrawal a later date. You are not taxed on the earnings on the annuity until withdrawn. These deferred annuities initially offered a set return. These are called fixed annuities. Over the last several decades there has been big push to shift the investments in these deferred annuities. You can pick and choose the investments in many of these annuities, oftentimes in mutual funds. These versions of deferred annuities are called variable annuities.
The performance of variable annuities are tied to the underlying investments in the annuity. With these types of annuities, the annuity is basically a wrapper around your investment that allows you to defer paying income tax on your growth until it is withdrawn. You then pay tax on all the growth at ordinary income tax rates. Variable deferred annuities are now very heavily marketed by the industry.
The reason that variable annuities are popular with annuity companies is that the investment risk is shifted from the annuity company to you, the annuity holder. In addition, the annuity companies charge you fees for holding your money in that annuity wrapper. According to industry disclosures, these fees average about 2% per year.
There is another type of deferred annuity that is popular with annuity sellers, equity indexed annuities. These annuities are marketed offering you the benefit of market upswings, but not the downturns. If you think that this sounds too good to be true, there is good reason. There seems to be a consensus among the non-company affiliated experts whose writings I have read, the benefit of these annuities are to the annuity companies and salespersons and not to the investor.
Furthermore, there are surrender charge penalties on most all deferred annuities if you take out more funds than the contract allows before a certain time. I have seen surrender charge penalties as high as 50% and penalty periods as long as 20 years. The surrender charge penalties are there to make sure the commissions paid to the annuity salesperson are covered. Annuity salespersons love annuities because they are among the highest commission financial products sold.
Now I am done describing annuities, let’s now talk about what is means to be “Medicaid friendly.” If you have a deferred annuity that is not “Medicaid friendly,” before you can qualify for Medicaid to pay for your nursing home care, you have to cash in the annuity and pay all the surrender charge penalties. With the remainder, you either have to spend the amounts down on nursing home care, or if you have the proper estate planning documents in place, you can protect those amounts for your loved ones.
I saw one client lose 50%, that is one-half, of his annuity investment to surrender charge penalties when he cashed in his annuity to qualify is wife for Medicaid to pay for her nursing home care. Had the amounts not been in an annuity, we could have protected all of his investment.
Now to the “Medicaid friendly annuities.” These are basically deferred annuities which can be converted into an immediate annuity if you go into the nursing home. Now you would have a monthly payment instead of a large asset, which could allow you to qualify more easily for Medicaid.
The good news is that you qualify for Medicaid for your nursing home care. The bad news is that you and your loved ones do not get to keep any of the funds that you put in the annuity.
Firstly, when you qualify Medicaid, all your income, less health insurance premiums and a $60 personal allowance, has to be paid to the nursing home. This is called the patient pay amount. Medicaid only pays the nursing home the difference between your monthly cost of care and the patient pay amount. The monthly annuity payment is considered income to you, and just increases the patient pay amount, so it all goes to the nursing home.
Secondly, when you convert the annuity to monthly payments, you have to name the State of Michigan as the primary beneficiary to the extent of Medicaid benefits paid. If you die before the annuity is all paid out, whatever is left, first goes to the state to pay back Medicaid. Only after the state is reimbursed for all the Medicaid benefits paid on your behalf, would your loved ones get anything.
As you can see, “Medicaid friendly annuities” are friendly to Medicaid, but not to you and your loved ones. These annuities are also friendly to the annuity salespersons who received a big fat commission for selling the annuity to you. If you have a deferred annuity that is not “Medicaid friendly,” you are actually better off than with a “Medicaid friendly annuity. You can protect more of it.
And you would be better off still, if you had no annuities at all. In that case, if you do enter a nursing home, you can then have funds to purchase a special type of immediate annuity that is “Medicaid compliant” to protect the maximum amounts for your loved ones that the law allows. The salespersons do not have much interest in these types of annuities because they pay little or no commissions.
Medicaid and asset protection planning is not for do-it-yourselfers. This often results Medicaid ineligibility for many months and additional costs and expenses. Do not attempt to do this on your own. Consult with a knowledgeable elder law specialist, who can advise you properly.
By: Matthew M. Wallace, CPA, JD
Published edited March 29, 2015 in The Times Herald newspaper, Port Huron, Michigan as: Friendly annuity may not be friendly