Advance Medicaid Planning
Planning to become eligible for Medicaid to cover the cost of nursing home care generally takes place in one of two circumstances. In the first – advance planning – the individual or couple is planning ahead for the possibility that they may need long-term care in the future. In the second – crisis planning – a spouse, child or other family member is seeking to preserve as much of the assets as possible in the face of a costly nursing home placement that has occurred already or that is imminent.
While it’s never too late to take some planning steps, you have more options if you plan ahead, in large part due to the five-year look back period for transferring assets. (Learn about The Complicated Medicaid Transfer Rules here.)
Following is a discussion of the advance planning steps you might take while healthy, understanding that each involves a trade-off and only you can decide what makes the most sense for you in your particular situation.
Giving Assets Away
An initial question is for whom are you protecting assets: yourself and your spouse, your children and grandchildren, someone else, or a combination of the above? If the reason you saved during your life was to provide for your old age and that of your spouse, if any, then keep your savings and use them for the rainy day, when and if it arrives. If you would like to be sure to pass your savings on to your children, and you cannot afford long-term care insurance or are not insurable, the best way to be sure they get what you want them to inherit is to give it to them now.
Of course, there are a lot of potential problems with giving your savings away. Remember that any transfer can cause you and your spouse to be ineligible for Medicaid benefits for up to five years following the transfer. Make sure that you keep enough funds for your needs, whatever they may be, during that entire ineligibility period. You may give money to your children with the understanding that they will hold it as an informal trust to be available to you if it’s ever needed. But don’t count on this working. Your children could run into financial problems, get divorced, fall ill, or pass away, resulting in the money disappearing. Or one child may spend the money while the others make it available to you, resulting in continuing resentments among your children.
We’ve seen cases where parents give their house to their children and are then evicted, whether because the child wants to sell the house or there’s a disagreement about whether the parents can stay in the home or need care that can only be provided in an assisted living or nursing facility. Also, a gift of an appreciated asset, such as a home, to children, can result in them paying more taxes on its sale than they would if they had instead received it as an inheritance. All too often, we have clients who make gifts to children and grandchildren and then need Medicaid within five years, creating difficult placement issues, especially when the children cannot return the transferred funds, which is usually the case.
The point of these warnings is that while transferring assets today guarantees that they go to your children, doing so carries significant risks.
It is possible to transfer assets out of your name for Medicaid purposes but still receive some benefit from them by putting them in an irrevocable trust if it is drafted to say that while the income is payable to you for life, the principal cannot be paid out to you or your spouse. At your death, the principal is paid to your heirs. This way, the funds in the trust are protected and you can use the income for your living expenses. However, if you do move to a nursing home, the trust income will have to go to the nursing home. (The state Medicaid agencies have their own rules about what trust terms are permitted, so you will need to work with an elder law attorney in your state to structure the trust properly.)
You should be aware of the drawbacks to such an arrangement. First, it is very rigid, so you cannot gain access to the trust funds even if you need them for some other purpose. Think of it as the proverbial “lock box.” Second, as noted above, the potential ineligibility period for transfers to trusts can be five years. For this reason, you should always leave an ample cushion of ready funds outside the trust.
This type of trust has three advantages over a direct transfer to children: First, you continue to receive the income. Second, the funds are not at risk, as they would be if placed in a child’s name. Third, at your death, your children will receive the funds with a step-up in basis, eliminating the capital gains tax risk of a direct transfer mentioned above.
You may also choose to place property in a trust from which even payments of income to you or your spouse cannot be made. The trust may be set up to permit distributions to or for the benefit of your children, or others. These beneficiaries may, at their discretion, return the favor by using the property for your benefit if necessary. However, there is no legal requirement that they do so. And you shouldn’t make a habit of doing this or the Medicaid agency may rightfully argue that the trust is a sham and that the funds are really being held for your benefit.
Lynn and Oliver consult with an elder law attorney about Oliver’s mother, who is deteriorating. The family has hired some help for her, but they see nursing home care in her future. She has sold her house to move to an assisted living facility. Oliver reports that his mother has about $500,000 in savings, of which $150,000 is in certificates of deposit and bank accounts and $350,000 is in highly-appreciated stock.
Lynn and Oliver discuss with the attorney the possibility of transferring half of this amount, with the result that Oliver’s mother could not apply for Medicaid coverage for the subsequent five years, but leaving her with enough funds to pay for her care during this time. The problem is which funds to transfer. If they transfer the stock, Oliver and his siblings will receive it with their mother’s basis, meaning that when and if they sell it, they will have to pay a large tax on capital gains. This would not be the case if they inherited it from their mother, because the basis would be stepped up to its value on her date of death.
The attorney explains that an alternative would be to transfer the funds into an irrevocable trust drafted so that the children would receive a step-up in basis on their mother’s death. Oliver’s mother would transfer $250,000 of the most appreciated stock into the trust and keep her remaining savings and investments in her own name, spending them down as needed over the next five years. She’ll start with her cash. Once she runs through that, she will draw down her remaining stock, realizing capital gains as she cashes it out. However, she will be able to deduct her nursing home costs as a medical expense offsetting some or all of the income realized on the sale of the stock.
An alternative approach would be for Oliver’s mother to transfer the second $250,000 outright to Oliver and his siblings. If one of them then uses the money to pay for her care, that child can then take a medical expense deduction for these payments on her own tax return to the extent that they and her other health care costs exceed 10 percent of her adjusted gross income. She can then reimburse her mother for the tax savings, helping to stretch her money longer. There will not be much benefit to this approach until Oliver’s mother’s expenses get to be rather significant. In addition, choosing which child should pay the expenses and take the deduction depends on each child’s income and other health care expenses. An example can show how this works:
If a child whose income is $50,000 pays their mother’s health care costs (over and above the mother’s own income) of $50,000, she will be able to deduct expenses over $5,000, or a total of $45,000. At a marginal federal tax rate of 25 percent, this will result in savings of $11,250 (plus any state income tax reduction). In comparison, a child whose income is $100,000 will only be able to deduct costs over $10,000, resulting in a deduction of $40,000. But if her marginal rate is 28 percent, this results in federal income tax savings of almost the same amount: $11,200. (If the children are married, the rates and the tax savings may be lower.)
As you can see, especially when you mix Medicaid and tax planning, matters can get quite complicated. Consulting with a qualified elder law attorney is an absolute necessity.
Medicaid Planning with the Half-a-Loaf or Rule of Halves Strategies
Crisis Medicaid Planning Strategies
What’s a “Step-Up” in Basis and Why Would You Want It?
Don’t know how your trust works?
Whether you’re creating a plan, managing a trust, or are a beneficiary of a trust, this book is your easy-to-read roadmap.