An annuity is a common financial investment that is frequently sold to older persons. The restrictions which prevent an older person from taking funds out of an annuity are often not well explained at the time of purchase, and often are misunderstood by the buyer. This article is a warning and introductory explanation that the use of annuities can result in detrimental financial consequences for older persons who need skilled nursing care.

An individual with more than $1 million in investment assets will never qualify for governmental financial assistance for skilled nursing care. Therefore, this article is not relevant to millionaires, who should be advised by a fee-based registered financial advisor, such as a Certified Financial Planner. While not only millionaires, but anyone under age 70 who does not have a disqualifying medical condition, should consider Long Term Care Insurance as part of a financial plan for retirement, such insurance is not in itself an absolute safeguard against annuity problems.

Let’s begin with a general introduction to annuities. There are two kinds of annuity structures: deferred or immediate. A deferred annuity accumulates income on the investment of capital without paying taxes until the funds are withdrawn later, usually in retirement years. An immediate annuity is a device to provide income on a regular monthly basis, in exchange for a one time initial payment of capital. Ideally, this occurs by converting a deferred annuity to an immediate annuity as retirement income, to execute a strategy prepared years before with a Certified Financial Planner.

Deferred annuities are either fixed, which provide a guaranteed rate of interest, or variable, which perform in relation to economic conditions. The ideal purchaser is one whose income is at a career peak, whose mortgage and other debt is under control, and who is planning ahead, ten or fifteen years before retirement. Such a person’s goal is to defer taxes on the investment income, if not the principal, until retirement years, when income and related tax rates will be lower than during peak earning years.

When an uninsured need for long term care in a skilled nursing care facility occurs, the demand for monthly income can require serious adjustment of a financial plan. Within 100 days after hospitalization, Medicare will stop paying for the cost of skilled nursing care, which usually is greater than $100,000 per year at facilities in our area. This triggers an obligation to pay privately until one’s resources have been exhausted within legally defined standards.

Often, there is a waiting or “elimination” period after an annuitant has entered skilled nursing before funds can be accessed from a deferred annuity without penalty. The delay in receiving financial assistance while waiting through a 90 day elimination period can result in a net cost of as much as $25,000. The problem can be more complicated if it is the annuitant’s spouse who is receiving the skilled nursing care.

Immediate annuities also can be problematic if they do not meet the criteria of the Deficit Reduction Act of 2005 (DRA). Important DRA requirements for an older person who might need skilled nursing care during the term of an immediate annuity are that the annuity must be irrevocable, unassignable, have level payments throughout the term, be for a definite term of a period of time that is less than the annuitant’s life expectancy, and have contingent beneficiary language that is acceptable to the Department of Public Welfare (DPW). Such an annuity is deemed to be DRA compliant.

In measuring whether an individual’s financial ability to pay has been exhausted, DPW’s analysis categorizes money into either “income” or “resources.” It is beyond the scope of this article to explain how DPW’s definitions of these terms are neither common sense nor the same as how the terms are used in the annuity industry. But when an immediate annuity fails to meet DPW’s regulations, it can be counted as an available resource, even though it really is not. Only an attorney who is a member of the Pennsylvania Association of Elder Law Attorneys (see www.paela.info) is likely to understand these distinctions.

Under current law, when Medicare stops paying, Keystone Elder Law can reconfigure a middle class couple’s or single person’s income and resources so they can qualify to receive government financial assistance sooner than they would without that assistance. Annuities can limit or delay such a reconfiguration. Since the cost of skilled nursing care exceeds $300 per day, immediate implementation of a legal and financial strategy often saves tens of thousands of dollars. The ill-advised use of inflexible annuities can prevent this savings.

Unfortunately, older persons are often advised by their bank to exchange a mature Certificate of Deposit (CD) for an immediate annuity with a higher interest rate. Other times a salesperson at a storefront investment brokerage encourages an older person to exchange their life insurance for an immediate annuity which has an indefinite term. In both instances, annuities frequently are oversold as “guaranteed not to lose.” Without intending to judge motives for all transactions, buyers should be aware that commissions paid in relation to the sale of annuities are among the highest.

Like fire, an annuity can be a useful and sometimes essential tool; but improper use can trigger catastrophic consequences. Older persons should be cautious about buying an annuity from a bank, in exchange for a life insurance policy, or from an “advisor” who is really as a salesperson earning a transaction commission. I am licensed to sell annuities but will only do so as part of a response to an extended care crisis plan. We much prefer to consult with a client who is seeking the advice of a registered financial advisor, such as a Certified Financial Planner, who charges a flat fee for management of the client’s entire portfolio. Strategic advance planning can avoid or minimize the financial distress that accompanies an extended care crisis.

Dave Nesbit
Attorney