This is the first of two articles that will provide an introduction to annuities, and explain how some annuities can be harmful while other annuities can be helpful with respect to paying for care in a skilled nursing facility. We have several times shared information here about annuities, which are a type of financial investment that is sold by a life insurance company. Since our objective is to inform the public, this article avoids terminology I might otherwise use as a licensed insurance producer.
There are generally two types of annuities. Deferred annuities allow working persons a chance to invest so that investment income earned by their savings is compounded by not being taxed immediately. Immediate annuities convert a specific amount of cash into a contract right away to receive periodic income for some time period in the future.
Annuities are often promoted as a “guaranteed interest rate with no chance of losing” type of investment. That is not necessarily true. Annuity salespersons can be tempted by a sizeable front-end commission and little or no need for follow up service. Sometimes the pitfalls of annuities later surprise an uninformed buyer, who might have been impressed by a fancy presentation made at a free dinner.
Our general advice is that persons who are older than 65, and who have a net worth of less than $1,000,000 outside of real estate, should hesitate to purchase an annuity unless they have received independent advice from a professional who is familiar with annuities and who is not earning a commission from the sale. The reason is that nearly every annuity either has a significant penalty for early withdrawal, or a requirement for a significant stay in a nursing home before a withdrawal can be made without a sizeable penalty. Even if the interest rate is guaranteed, the cost of accessing the investment when needed to pay for nursing care results in an investment loss. This is one example of an annuity that is harmful.
Some annuities can be double-counted, as both a resource and income, when a person is applying for Medical Assistance (also known as Medicaid) from the Pennsylvania Department of Human Services (DHS) to help to pay the cost of care in a nursing home, which on average is around $9,000 per month. DHS has regulations which limit both resources and income for eligibility. Ideally, it is advantageous for an applicant for Medicaid if neither the contract price of an immediate annuity contract nor the discounted present value of future income is considered to be a reportable resource. An annuity that will be double-counted is harmful.
For an annuity to be counted by DHS as only cash and not also double-counted as a resource, the annuity must be irrevocable, nonassignable, and have payments in equal amounts during the term of the annuity, without any death benefit. The annuity must also be actuarially sound, which means that it cannot exceed the life expectancy of the annuitant. Further, DHS must be named as the beneficiary if the annuitant were to die during the term.
Few annuities that are sold commercially meet these conditions, which was confirmed by a 2009 federal court opinion in Wetherbee v Richman. Wetherbee was a case won by a Pennsylvanian who successfully disputed the denial of a Medicaid claim by the Commonwealth. Although the Wetherbee case was stamped as “non-precedential,” it has been cited nationwide by Medicaid-savvy lawyers to benefit a well spouse who remains independent in the community by increasing the well spouse’s income.
The benefit of increased income is achieved by converting “excess resources,” which DHS would otherwise require to be spent for the cost of the care of the spouse in the nursing home before getting Medicaid help, into additional income for the well spouse. For example, a couple who own a house and otherwise has joint martial assets of around $500,000 could redeploy $300,000 away from nursing care expenses. Those redeployed savings would be converted with a Medicaid-compliant annuity to increase the income of the well spouse by more than $5,000 per month for five years.
One legal issue which had remained in dispute after Wetherbee is the legal meaning of the term “actuarially sound.” In 2011 DHS refused to approve three Medicaid applications because they involved annuities with a term of less than two years. DHS argued that an annuity term of less than two years failed to pass “a sniff test.”
On September 2, 2015, the United States Court of Appeals for the Third Circuit resolved this four-year-old dispute and issued a thirty page opinion in Zahner v. Secretary of Pennsylvania Department of Human Services (DHS). The federal court disagreed with DHS and determined that “Congress did not require any minimum term for the annuity to qualify under the safe harbor.” The Zahner ruling built from the Wetherbee case and was noted as “precedential” federal law for Medicaid-complaint annuities.
The Zahner ruling enables a Medicaid-compliant annuity to be used as a safe harbor for a case of a middle-class resident of a nursing home who is single or widowed. This can enable an asset preservation strategy to cap a family’s liability for that parent’s nursing home expenses. Zahner also offers a solution for a responsible and proactive adult child(ren) to cure an uncompensated asset transfer that could otherwise result in liability for the adult child(ren) for the cost of their parent’s nursing care under Pennsylvania’s filial responsibility laws.
Next week’s column will begin where we leave off today. If you are an adult child who has a single parent in a nursing home, next week’s article will explain how to use Zahner proactively. Zahner can be a tool to help a parent who failed to buy long-term care insurance or to fix a financial family catastrophe caused by a sibling who, by coercion or sympathy, received funds from a parent who obtained no security to ensure repayment.
David D. Nesbit, Attorney