Case Study: Tax-Deferred Annuities & Texas Medicaid Planning

Have you heard about Texas’ take on tax-deferred annuities in Medicaid Planning?

In November, we published a blog, highlighting a recent change in the Texas Medicaid Agency’s interpretation of the word annuity, and detailed how – pursuant to the Texas Medicaid Handbook – your clients’ retirement assets may be transferred to a tax-deferred annuity (TDA), while still meeting Medicaid eligibility requirements. This gives you another tool, with greater flexibility, to help your clients planning for Medicaid. They can now choose either an immediate annuity, or a TDA, depending on their needs. Let’s explore an example:

Meet Ed and Betty

Ed is 82 years old, and has recently moved to a Texas nursing facility, which charges $5,400 per month for his care. Betty, his community spouse (CS), is in excellent health, and still living at home. At 82 years old, Ed’s Texas Medicaid life expectancy[i] is 7.14 years, or 85.68 months. Together, their countable resources total $350,000 of which $240,000 consists of Ed’s IRA. Ed’s monthly income is $1,500, while Betty’s income is $1,000. Yet, despite their limited income, the couple believes they have sufficient income to meet their needs.

The Goal

The goal of the plan is to obtain immediate Medicaid eligibility for Ed, and to provide a wealth transfer for future generations upon his passing.

Achieving Medicaid Eligibility

The easiest and most efficient means to achieve Ed and Betty’s goals is to transfer the entire value of Ed’s IRA into a Tax-Deferred Annuity (TDA).  In a case dealing with non-qualified/post-tax dollars, only $228,780.00[ii] of the couple’s resources would need to be spent-down. However, in this case, with the bulk of Ed and Betty’s resources being held in Ed’s IRA, transferring the entire IRA value of $240,000 to a TDA would be the quickest means of spending Ed down to $2,000 or less.

Their Options

Despite a TDA being the most attractive solution to convert Ed’s IRA from a countable resource into an exempt resource, and avoid immediate taxation of the IRA, Ed and Betty would like to explore the option of utilizing a TDA vs. a Single Premium Immediate Annuity (SPIA). A TDA is primarily used as a vehicle for accumulating savings, with the expectation of eventually distributing those savings.  Whereas, an immediate annuity is an income stream that is irrevocable and does not have any cash value.

The Solution: TDA

A TDA is not required to make monthly payments.  In that the TDA is being purchased with IRA funds, Ed has a Required Minimum Distribution (RMD) for IRS purposes that he can elect to withdraw at any time during the course of the year.

Depending on the TDA term chosen, ELCO Mutual Life and Annuity Company (ELCO) will provide the following guaranteed rates of return[iii]:

• 1-year Annuity 1.50%
• 2-year Annuity 1.75%
• 3-year Annuity 2.00%
• 5-year Annuity 2.65%
• 7-year Annuity 3.00%
• 10-year Annuity 3.20%

Assuming the entire $240,000 is utilized to purchase a 10-year TDA, and no additional contributions are made to the TDA, the potential accumulated value would be as follows:

With Ed paying approximately $5,400 per month for his nursing home care, by qualifying for Texas Medicaid benefits in the month of the annuity purchase, and his Medicaid monthly co-pay being $0, Ed and Betty will experience 100% savings. With the aforementioned TDA in place, Ed will qualify for Texas Medicaid benefits in the month of purchase. Additionally, with Betty having a Monthly Maintenance Needs Allowance (MMNA) of $2,980.50, and her monthly income totaling $1,000.00, Betty has a monthly income shortfall of the difference: $1,980.50. With this amount being shifted from Ed’s monthly income of $1,500 his net monthly income equals $0. As such, Ed’s monthly Medicaid co-pay to the nursing home equals $0.

The advantages of a TDA:

• tax-deferral/asset accumulation
• greater wealth transfer available upon Ed’s passing
• higher interest rates than a SPIA
• more flexibility as to how much, and when income is received
• reducing the annuity owner’s income reduces the IS’ co-pay to the nursing home

The Alternative: SPIA

Unlike a TDA, a SPIA is required to make periodic payments. Assuming the entire $240,000 is utilized to purchase an 85-month SPIA Ed would receive the following guaranteed monthly payments:

With Ed paying approximately $5,400 per month for his nursing home care, by qualifying for Texas Medicaid benefits in the month of the annuity purchase, and his Medicaid monthly co-pay being $2,343.99, Ed and Betty will experience monthly savings of $3,056.01. By purchasing the aforementioned SPIA, Ed will qualify for Texas Medicaid benefits in the month of purchase, increasing his monthly income to $4,384.49. Additionally, with Betty having a Monthly Maintenance Needs Allowance (MMNA) of $2,980.50, and her total monthly income of $1,000.00, Betty has a monthly income shortfall of the difference: $1,980.50. With this amount being shifted from Ed’s monthly income of $4,384.49 his net monthly income equals $2,403.99. Ed’s net monthly income is then reduced by his $60.00 monthly personal needs allowance, resulting in his monthly Medicaid co-pay to the nursing home equaling $2,343.99.

The potential pitfalls of a SPIA:

• lack of flexibility in the payment amount and the period certain/term chosen
• because it’s based on the Social Security Administration life expectancy table, income generated is substantially greater than income based on an IRA owner’s RMD for IRS purposes
• low interest rates – typically ranging from 0.30% to 1.5%
• for Medicaid Planning purposes, the SPIA increases the CS’ income, resulting in a greater co-pay to the nursing for the IS – less income shifting under MMNA regulations

As illustrated above, moving excess resources into a TDA, rather than a SPIA, is an attractive option for many Texas Medicaid applicants. If you have clients, not necessarily needing an additional income stream, you might want to suggest using a tax-deferred annuity for Medicaid spend-down purposes. To find out more about the tax-deferred annuities, and other Medicaid compliant products, we have available, call us today!

[i] The 85 month term is based on Ed’s Texas Medicaid life expectancy; Texas uses the Actuarial Life Table, as published by the Social Security Administration, found here.

[ii] This amount was determined by subtracting the Community Spouse Resource Allowance of $119,220 and the institutionalized individual’s resource allowance of $2,000 from the total countable resources of $350,000.

[iii] These annuities are underwritten by ELCO Mutual Life & Annuity, Lake Bluff, Illinois. Policy forms SPD11-05 and SPD11-10. Surrender charges apply for early withdrawals; see policy form for details.