Annuities and Medicaid eligibility: how states treat an annuity purchase

Medicaid pays for nursing home care and some home care once a person's countable assets and income fall low enough, and an annuity can sit on either side of that line. An annuity you already own is usually counted as an asset if it can be cashed in, or as income if it is paying out. An annuity you buy shortly before applying is looked at as a possible transfer of assets, and unless it meets specific federal conditions, the state can treat the purchase as a gift and delay your eligibility. Because states set many of the details, this is one of the topics where a local elder law attorney earns the fee.

What follows is a set of questions that families actually ask, answered at the level of how the rules work. It is not legal advice, and it does not describe any one state. Amounts and procedures change, and state Medicaid agencies publish their own manuals.

How Medicaid sees an annuity

What is Medicaid asking when it looks at an annuity?

An application for long-term care Medicaid asks three things about money. How much do you own that counts? How much income do you receive? And did you give away or sell anything for less than it was worth in the recent past? An annuity touches all three.

Before payments start, a deferred annuity looks like savings. After payments start, it looks like income. At the moment you buy one with a lump sum, the agency asks whether you received fair value in return, or whether the premium was really a way to move countable money out of reach. The 2005 federal Deficit Reduction Act tightened the rules for that last question, and the federal statute on transfers (42 U.S.C. §1396p) now requires applicants to disclose any annuity on the application and sets the conditions an annuity must meet to avoid being treated as a transfer.

Does Medicaid count an annuity I already own?

Often yes. For a deferred annuity you can still surrender, many states count the amount you could actually receive: the surrender value, after any surrender charge. A contract you cannot cash in, because it has already been converted to payments, is usually treated differently: the cash value stops being an asset and the payments become income. States vary on the details, including how they treat a contract with a long surrender schedule that locks the money up.

An annuity held in an IRA or other retirement plan is a separate question. Many states count the account's value as an asset, sometimes net of penalty and tax, and others treat required minimum distributions as income and the balance as exempt while the owner is taking them. The rules differ enough that nobody should assume one answer. This is also where qualified annuity and non-qualified annuity differ for the application: the label tells the agency whether tax will take a share of any withdrawal.

Does buying an annuity count as giving money away?

It can. A purchase is treated as a transfer for less than fair value, which means a penalty, unless the annuity meets conditions that the federal law spells out. The widely used shorthand for those conditions is a "Medicaid-compliant" annuity. The commonly cited requirements are:

• It is irrevocable, so you cannot cash it in or change the terms.
• It is non-assignable, so the payments cannot be sold or transferred.
• It is actuarially sound, meaning the payments are expected to return the premium within the annuitant's life expectancy according to a table the state uses. A seventy-eight-year-old cannot buy a twenty-year payout and call it compliant.
• It pays in equal installments, with no deferral and no balloon payment at the end.
• The state is named as a remainder beneficiary, as discussed below.

A contract that fails any one of these can be counted as a transfer, and the whole premium may become the amount the agency penalizes. An annuity that meets all of them is considered a purchase of income rather than a gift, which is why attorneys use single premium immediate annuities when they use annuities at all. State requirements and the list of documents they want can go further than this summary, so the contract and the agency's current manual are the final word.

The state's claim and the income an annuity creates

What does the state get when I die?

A compliant annuity usually has to name the state as the first remainder beneficiary, up to the total Medicaid paid for the person's care. If the annuity still has payments due when the annuitant dies, the state is paid first, up to what it spent. When there is a surviving spouse or a minor or disabled child, the state may take second position behind them, depending on the rule. This provision is aimed at ensuring the program recovers its costs rather than leaving a remaining balance to heirs. You can read the general outline of what an annuity pays at death in what happens to an annuity when you die, but those rules are overridden by the Medicaid beneficiary requirement for a compliant contract.

The state is also free to pursue the rest of the estate. Federal law requires every state to seek recovery from the estates of certain long-term care recipients after death, and states define "estate" differently, so annuity payments that pass through a beneficiary designation may or may not be reachable. Ask the attorney how your state defines it.

How does annuity income affect eligibility?

Payments count as income for the person who receives them. For a single applicant, that income is generally applied toward the cost of care. Medicaid lets the person keep a small personal needs allowance and any health insurance premiums, and the remainder is paid toward the nursing home bill, an amount often called patient liability or share of cost. A single person who buys a short-term annuity to "spend down" has not removed anything from the countable pile in a useful way: the payments go to the nursing home anyway, and the state will have claim to what is left.

For a married couple, the situation can be different, which is why most of the discussion about annuities and Medicaid involves a couple where one spouse needs care and the other, the community spouse, stays at home.

Why do married couples treat annuities differently?

Federal spousal impoverishment rules protect part of a couple's resources and income for the spouse who remains at home. The amount a community spouse may keep is set by a formula that includes federal minimums and maximums adjusted every year, and states choose within the range, so look it up rather than relying on a number you read last year. Countable assets above the protected amount have to be spent down before the spouse who needs care qualifies.

In many states, income is attributed by whose name is on the check. That means income paid to the community spouse is not available to the spouse in the nursing home, though the community spouse may be expected to use any income below a state-set minimum for her own needs before drawing on the other spouse's income. If those facts are true in your state, an immediate annuity payable to the community spouse converts excess countable assets into her income, while the contract meets the compliance rules.

Here is a hypothetical to show the arithmetic, using invented numbers. Raymond enters a nursing home. His wife Joan stays at home. After setting aside the home and a car, which are generally exempt, the couple has $300,000 in countable assets. Assume, for illustration only, that their state lets Joan keep $100,000 and Raymond a small amount, call it $2,000, and that no other protections apply.

• Countable assets: $300,000.
• Protected for Joan and Raymond: $100,000 + $2,000 = $102,000.
• Excess that must be spent down: $300,000 − $102,000 = $198,000.

One lawful route is to spend the $198,000 on things the couple needs: home repairs, a replacement car, prepaid funeral arrangements that are irrevocable, or care. Another route, for the attorney to weigh against the first, is a compliant immediate annuity in Joan's name. If the term is five years, which is shorter than Joan's life expectancy in the state's table, then, with interest ignored to keep the arithmetic plain, $198,000 divided by 60 months is $3,300 a month. Real payments would run higher than that because the insurer credits interest, and the state remains the first remainder beneficiary if Joan dies before the payments end. The $198,000 is no longer a countable asset, and Joan's income rises by about $3,300 a month for five years, which is taxable to her. Whether the plan helps depends on her other income, the state's income rules and the cost of care.

Nothing here is a recommendation. The same facts could lead one attorney to the annuity and another to spend down on a house roof, a hybrid policy for the spouse at home or something else. The details of the state's rules matter more than any general strategy.

Penalties, strategies and state differences

How does the look-back period work with an annuity?

Medicaid reviews financial transactions during the 60 months before an application for long-term care. If it finds that you gave away assets or sold them for less than fair value, it can impose a penalty period during which Medicaid will not pay for long-term care even though you are otherwise eligible. The length is the amount transferred divided by a figure the state publishes, often called the divisor, which represents the state's average monthly private-pay cost of a nursing home.

A hypothetical shows how an annuity fits. Suppose the $198,000 above had gone into an annuity that failed the compliance tests, and suppose the state's divisor were $9,900 a month. The agency treats the full amount as a transfer: $198,000 ÷ $9,900 = 20 months. For those twenty months, the person needing care has no Medicaid coverage for the nursing home, and has few assets left to pay for it. That is the downside of an annuity that looks compliant to the buyer and is not. The divisor here is invented. States change theirs, and some states apply penalties in different ways, particularly when the transfer comes in several pieces.

Why can't I buy a deferred annuity to hide the money?

A deferred annuity is rarely compliant because it normally has no payments for years and, if it is revocable, it can be cashed in. The agency will count its surrender value as an asset, or treat the purchase as a transfer if it has been made irrevocable without equal payments. Contracts of this type may be appropriate for other goals, but they do not turn countable money into non-countable money for Medicaid purposes. Using one for that purpose is among the more common reasons applications are denied and why the annuity-sales abuses aimed at seniors, covered in annuity sales abuses targeting seniors, are taken seriously by regulators.

Can I convert an annuity I already own into payments?

Sometimes. Converting, or annuitizing, an existing contract changes its status, so that the cash value becomes an income stream. The question is whether the payments meet the same standards: irrevocable, non-assignable, actuarially sound and equal. If the existing contract allows a payout option that satisfies those standards, and the state accepts it, the conversion avoids the transfer problem because no new premium is being paid to a third party. If the available options do not satisfy the standards, a stream that is too long, for instance, the agency may treat part of the value as a transfer. Conversion is also taxable in part, as explained in the exclusion ratio: how annuitized payments split into basis and gain, so the tax effect belongs in the same conversation.

Do states agree on all of this?

No. The federal law sets a floor, and each state adds its own definitions, forms, limits and sometimes stricter rules. Areas where states commonly differ include how they count retirement accounts, how they treat the community spouse's income, how they calculate penalty periods, whether they allow a gift plus an annuity strategy sometimes called "half-a-loaf," and how aggressively they review annuity purchases. A few states have rules specific to annuities that reach beyond the federal minimums. Do not rely on articles that were written for another state, and do not rely on one written years ago. The agency that runs your state's Medicaid program publishes eligibility manuals, and an area agency on aging can often point you to free or low-cost legal help for seniors.

What about life insurance and burial funds?

They are separate asset categories with their own rules, summarized in medicaid eligibility and life insurance cash value. The short version is that term insurance usually does not count, cash value in whole life can, and an irrevocable funeral arrangement is often exempt. Those rules matter when the couple is deciding what to spend down and in what order.

Alternatives and getting help

What else could the money be used for instead?

Several things come up in these conversations. The first is paying for care privately for a period, which preserves choices of facility and may be a better fit when care is expected to be short. A second is a hybrid life and long-term care policy bought years before care is needed, covered in hybrid life and long-term care policies, although it does nothing for someone who needs care now. A third is home and community-based services, which some states fund through Medicaid waivers with their own eligibility rules. A fourth is leaving the money where it is, if the person is not near needing Medicaid. People whose health is stable sometimes buy an annuity for ordinary income reasons, as described in what is an annuity and how does it work?, and have no Medicaid purpose at all.

When does an elder law attorney matter, and what should I ask?

An elder law attorney matters whenever a nursing home stay is likely within a few years, a spouse will stay at home, or any large transfer or annuity is on the table. The look-back, the divisor, the compliance tests and the state's recovery rights interact, and a mistake can cost months of coverage. State bar associations usually run referral services, and elder law attorney organizations list members by state.

Questions worth bringing to the first meeting:

1. Which of our assets does the state count today, and which are exempt?
2. How does the state treat annuities and retirement accounts specifically?
3. What is the divisor now, and how long would a penalty be on each transfer we might make?
4. If an annuity is part of the plan, does the exact contract meet the state's tests, and who names the state as beneficiary?
5. What income would the spouse at home receive, and how is it taxed?
6. What does the plan cost in fees, and what happens if the person needing care dies earlier or later than expected?
7. What are the alternatives and what would you choose in our shoes?

Insurance agents are licensed to sell annuities. They are not usually the right people to say whether a purchase protects Medicaid eligibility, and a sales presentation that promises protection should be treated with caution. The state insurance department and the Medicaid agency can both be asked how a given product is handled.

Key takeaways

• Medicaid counts an annuity as an asset, as income or as a possible transfer, depending on whether it can be cashed in, is already paying and was bought within the 60-month look-back.
• A purchase avoids the transfer penalty only if it is irrevocable, non-assignable, actuarially sound, paid in equal installments and names the state as a remainder beneficiary.
• Married couples can sometimes shift countable assets into income for the spouse at home, but the numbers and the state's income rules decide whether that helps.
• A failed annuity can be penalized as a gift: in the hypothetical above, $198,000 divided by a $9,900 divisor is 20 months without coverage.
• States differ in important ways, so a local elder law attorney, not the person selling the annuity, is the right adviser.