When it comes to choosing between a Promissory Note or a Medicaid Compliant Annuity (MCA), there are many factors to consider when determining which spend-down strategy will best serve your client. Both tools must adhere to the specific conditions as set forth in the DRA of 2005 and, when structured and administered properly, both can help your client achieve accelerated Medicaid eligibility in a crisis planning situation. However, it is important to also consider the deficiencies of each spend-down strategy and how those differences could impact your client.

Promissory Notes:

Availability:

To begin with, it is important to note that the use of Promissory Notes as a spend-down strategy is not permissible in every state. As such, knowing whether Promissory Notes are available for use in your state and how they must be specifically structured to comply with your state’s Medicaid requirements is imperative.

Definition:

One of the primary differences between a Promissory Note and a Medicaid Compliant Annuity is who administers the contract. A promissory note is a written instrument in which one party (the issuer) promises to pay a specific sum of money to another party (the payee). The agreement is typically between family members and commonly between a parent and their adult child.

Structure:

Similar to an MCA, the goal of the Promissory Note is to effectively convert excess countable resources into a future monthly income stream. This is typically achieved by the issuer essentially replacing a countable resource they are wishing to spend down with the payee in return for a monthly income stream. The funds are then returned to the issuer, with interest, over the term of the note.

In order to be considered ‘Medicaid Compliant,’ the Promissory Note must be non-assignable, actuarially sound, provide equal payments with no deferral or balloon payments, and must not be self-canceling. In other words, should the issuer predecease the term, the remaining monthly payments must continue to be paid to the issuer’s estate for the duration of the term.

Advantages: 

Depending on your client’s specific crisis planning scenario, sometimes the benefits of using a Promissory Note can outweigh that of using an MCA. One such example, is if the owner is wishing to transfer non-cash assets, such as a family cottage or timeshare, to their intended beneficiaries. The Promissory Note allows for this type of transfer of real estate without the owner having to sell the property and fund an MCA with the cash proceeds. Because the Promissory Note can be composed between family members, it can often be established with very little upfront cost to the Medicaid applicant.

Disadvantages: 

Should a Medicaid applicant prefer to spend down their excess assets through a Promissory Note that is administered by a close family member, it is imperative that the individual administering the contract does so properly and with great care. In the event that the payee encounters a financial hardship such as divorce, gambling, bankruptcy, or death and is unable to fulfill the terms of the promissory note, the transaction will no longer be considered ‘Medicaid Compliant.’ Consequently, failure of the payee to uphold the contract may result in a termination of the applicant’s Medicaid benefits.

Furthermore, should the owner predecease the term of the Promissory Note, the remaining payments must continue to be paid to the owner’s estate. Often times, the estate of the Medicaid applicant is subject to estate recovery by the state Medicaid agency up to the amount of benefits that have been expended on the applicant’s behalf. Moreover, the use of a Promissory Note may require more long-term maintenance and supervision by an elder law attorney over the course of the agreement and may attract greater scrutiny by the state Medicaid agency upon review of the initial application.

Learn More: Elder Law Interview Featuring Nina Whitehurst, J.D.

Medicaid Compliant Annuity: 

Availability:

In contrast, Medicaid Compliant Annuities are more widely recognized and accepted. These immediate annuities are permitted for use in Medicaid planning nationwide.

Definition: 

An MCA, on the other hand, is an insurance contract that is purchased through an insurance company. Once the contract has been annuitized, the insurance company will pay monthly payments to the policyholder in exchange for a lump-sum premium payment that was used to initially fund the policy.

Structure: 

While a Medicaid Compliant Annuity can also be utilized in a similar fashion as a way to convert excess countable resources into a future monthly income stream paid to the owner, the structure of the annuity is a bit different. Rather than the payments being managed by a family member or other individual known to the applicant, the annuity is controlled and administered by the insurance company. An MCA that does not adhere to the structural requirements of the DRA may be considered a divestment or transfer for less than fair market value. As such, the MCA must be irrevocable, non-assignable, actuarially sound, provide equal monthly payments, and name the State as the appropriate beneficiary.

Advantages:

In contrast, the MCA may be advantageous to a client that is wishing to spend down a tax-qualified account and avoid the immediate tax consequences of liquidation or does not have a reliable contact they can depend upon to administer the contract. In those scenarios, it may provide a superior benefit to the applicant to fund an MCA, instead.

Since the annuity is established with an insurance company the monthly payout is guaranteed and often requires very little follow-up work for the elder law attorney once the annuity is in effect. Given that the MCA is widely recognized in most states, the annuity often receives much less scrutiny by a Medicaid caseworker and can be funded with either non-qualified or tax-qualified funds.

Disadvantages:

One disadvantage to utilizing an MCA when purchasing a shorter-term annuity is that there may be a processing fee associated with the establishment of that annuity. This processing fee is often required to ensure that the annuity meets the necessary state-specific requirements and complies with the insurance company’s requirements for submittal.

Lastly, the Medicaid Compliant Annuity is unable to be funded with non-cash assets, and should the contract owner predecease the annuity term, the remaining proceeds are typically recovered by the State Medicaid agency as the required beneficiary, up to the amount of benefits they have expended on the applicant’s behalf.

To learn more about when to use a Promissory Note or MCA for your client’s Medicaid spend-down, click here to view our free webinar on the topic presented by the President and CEO of Krause Financial Services, Dale Krause, J.D., LL.M.