Using Trusts for Medicaid and Benefits Planning - Module 4 of 6
Module 4: Medicaid and Benefits Planning
Medicaid is a hybrid federal and state program that provides health care services for those who cannot afford to pay for their own. It is administered by local Department of Social Services, which are representations of state governments, but the program is funded evenly between the federal government and the individual states.
Although state law determines how Medicaid is administered within the state, federal funding of Medicaid is conditioned upon adherence to a series of complex federal regulations.
Since Medicaid was enacted in the 1960s, virtually all federal Medicaid statutes and amendments have come with provisions that states are required to follow federal regulations or lose their Medicaid funding. This trend was limited by the United States Supreme Court decision in National Federation of Independent Business v. Sebelius, better known as the “Obamacare” case. Although the case is famous for upholding the Affordable Care Act, an important but sometimes overlooked facet of the decision ruled that requiring that states follow each new federal Medicaid adjustment or lose their entire Medicaid funding was an unconstitutional violation of federalism. As such, many of the Medicaid expansion rules under the ACA were not enacted by all states. Still, because of federal regulation that governs much of this area, there is quite a bit of uniformity in Medicaid rules throughout the country.
Medicaid programs apply both asset-based and income-based tests for determining Medicaid eligibility. That is, to be eligible for Medicaid a person may not have access to significant resources or have more than a specified minimal income. The exact income and asset limitations vary from state to state. They also vary based on familial status, age, disability and a variety of other factors. Giving examples of income and asset limits in a vacuum is pointless since there are so many factors at play. A quick Internet search, however, will usually suffice to allow you to learn the income and asset limitations based on your status and family for your local Medicaid program.
Because of the exceedingly low asset and income limitations, most people engaging in estate planning are not immediately eligible for Medicaid. Because of the common need for extremely expensive care for elderly people that is not covered by Medicare (Medicare, for example, may cover nursing home stays if they are temporary and rehabilitative, but will not cover them if their long-term or permanent), Medicaid is a common payer of long-term care needs for elderly estate planning clients.
Medicaid Planning Alternatives
Before we discuss Medicaid planning, we should briefly look at the alternatives:
1. Private pay. With no planning, clients are essentially planning to pay for long-term care healthcare needs with private pay. In many areas of the country, an average nursing home costs more than $10,000 per month. At this rate, people who worked their entire lives to the amass a few hundred thousand dollars to leave to their children will find their assets completely dissipated in a few short years. While private pay is certainly an option for wealthy people, most people want to try to avoid this sort of economic outlay.
2. Long Term Care Insurance. Just as health insurance is purchased as a hedge against expensive health care bills, car insurance to protect in the event of a car accident and life insurance to provide for a family in the event of an untimely death, long-term care insurance is available to pay for long-term care needs. Premiums vary widely depending on the age and health status of the insured. Because most people do not need long term care services such as nursing home care until well into the 70s or 80s, people who have the foresight to purchase such a policy when they’re young can find the premiums quite reasonable.
However, even assuming the premiums are affordable, people looking to purchase long-term care insurance policies should be aware of a few potential pitfalls that can apply to many policies:
a. Maximum benefit amount. The maximum benefit amount of long-term care policy is measured in benefits per day of care. If the client is purchasing insurance to protect against the possibility of needing nursing home care and the average nursing home in the area charges $400 per day, the client should ensure that the policy pays at least that much in benefits.
b. Duration of coverage. Many long-term care plans do not paid benefits indefinitely; but rather are limited in duration. A healthy insured may need long-term care for many years and if a nursing home stay exceeds the duration limitation, then the client will be in a similar position to those who have no long-term care insurance at all.
c. Protection against inflation. Some policies allow the benefits to increase to correct for inflation between the time that the policy is purchased and when the benefits are needed. Without this feature, determining what long-term care expenses will be like in 20 or 30 years is all but impossible.
3. The third option is Medicaid planning. Medicaid planning is a catchall term that refers to the process of “impoverishing” oneself to become eligible for Medicaid. While this may sound “wrong” or unethical, it’s actually not only legal and ethical, but is quite a common estate planning device and can be done legally and ethically as long as everything is done “above board,” so to speak. Because Medicaid is limited to applicants with very low asset levels, Medicaid planning means removing virtually all assets from the client’s name and control. While this doesn’t necessarily have to be done with a trust, establishing and funding a trust can be an efficient and effective to reduce one’s assets and can accomplish many other goals at the same time. The rest of this module will focus on the applicable Medicaid rules that must be kept in mind when establishing and funding a Medicaid planning trust.
Medicaid planning typically revolves around the possibility that a client may eventually have to be placed in a nursing home or other long-term care facility. Medicare, which most seniors are eligible for, will pay for temporary and rehabilitative nursing home stays, but will not pay for longer or permanent nursing home residences. In fact, Medicare will usually pay for no more than 100 days in a nursing home and will stop paying for nursing home in less time as soon as it determines that the stay is permanent and not rehabilitative. Therefore, the only government program that can realistically pay for permanent or long-term nursing home stay is Medicaid.
The Five-Year Lookback Period
Medicaid has always been designed to be a “payer of last resort.” Therefore, federal law takes steps to try to ensure that people don’t use shortcuts to pay for long-term health care services that the applicant really has the means to pay for. To prevent elderly people with significant assets from gifting away their assets and then becoming immediately eligible for Medicaid, federal law imposes a five-year period of ineligibility that follows a gift of assets to anyone other than person’s spouse.
Under this rule, a person who gives a gift and then applies for Medicaid within five years of the date of that gift must wait a “transfer penalty period” before being eligible for Medicaid assistance. This penalty period is the number of months that is equal to the value of the gift divided by the average monthly nursing home cost in the applicant’s area.
For example, say that a client transfers $100,000 as a gift to his daughter on January 1, 2019. On January 1, 2020, the client applies for Medicaid. Assume that the average monthly nursing home cost in his area is $10,000. Because $100,000 divided by $10,000 is 10, the client must wait 10 months (until November 1, 2020) before the government will start paying for his nursing home through Medicaid.
This “lookback” rule essentially stops people from applying for Medicaid for five years after the date of a large gift. After five years, however, the lookback period expires and the client can be eligible for Medicaid immediately. In our previous example, if the client can hold out until January 1, 2024 before applying for Medicaid, and assuming his asset level on that date is low enough to secure eligibility, he will be eligible. The gift could have been $5 million instead of $100,000 - it matters not. As long as you wait five years from the date of the gift before applying, there is no transfer penalty.
It is therefore important that people engage in Medicaid planning, if at all, at least five years before they anticipate require nursing home care. While this can, of course, not be predicted with precision, many practitioners suggest that clients start engaging in Medicaid planning while in their 60’s or, at the latest, early 70’s, as statistically, people start becoming more likely to require nursing home care as they reach their late 70’s and early 80’s.
The Medicaid planning trust is a device that can serve to hold a person’s assets for the benefit of his or her children, heirs or other beneficiaries, while allowing the transferor to become eligible for Medicaid. While Medicaid trusts can vary greatly, there are two defining characteristics that apply to all Medicaid trusts. The first is that the trust is irrevocable, meaning that the grantor has no power to revoke, modify or alter the trust. The second is that the trust principal may not be used for the support or healthcare expenses of the grantor. In the case of a married couple, the trust should not allow its principal to be used for the support or healthcare of either spouse. If the trust had the ability to pay for healthcare expenses or if the grantor retained control over the trust, the entire trust principal would be considered an “available resource” for the grantor and would thus make the grantor ineligible for Medicaid.
It’s unclear whether a trustee’s discretionary power to pay for the grantor’s expenses would count as an available resource. For example, what if the trust says that the trustee “may, at her discretion, pay for expenses of the grantor” but gives the grantor no control or say in the matter? It is conceivable in such a case that a Department of Social Services official could take the position that, even though the grantor has no direct control over the assets, the trust funds should be considered available to him. This is especially true if the trustee is the grantor’s family member and the assets originally belonged to the grantor in any case. While this can no doubt be argued about and litigated if necessary, the safest play is simply to not make the grantor a potential beneficiary of the trust. If the grantor does need money for living expenses, there is of course, nothing stopping his family members from supporting him or giving him money. The arrangement whereby the grantor is made dependent on his children or family members may not be the most comfortable and for the client, but it certainly the safest from a Medicaid planning perspective.
In fact, to ensure that the trust assets are not considered available to the grantor, many Medicaid planning trusts specifically state that “no distribution may be made from this trust that would result in any benefit to the grantor or the grantor’s spouse; nor shall any distribution be made from the trust that would displace any legal support obligation of the grantor.”
Income Only Trusts
For clients who are uncomfortable with being completely dependent on their families, a compromise option exists. That is, the Medicaid planning trust can distribute its income to the grantor on a regular basis. This allows the grantor to be supported (at least partially) by interest and other income earned by the trust, while protecting the trust principal.
It should be noted, however, that if the client is able to receive income from the trust, that income will be vulnerable in the event of a Medicaid need. Keep in mind that Medicaid has strict income limits in addition to strict asset limits. Income over and above those limits will need to be “spent down” on the grantor’s healthcare before Medicaid will pay for the rest. Income that is earmarked for the grantor is also vulnerable to creditors’ claims against the grantor. By requiring or allowing the trust to give its income to the grantor, the grantor is trading off protection of that income. Whether to make this trade-off is an individual decision that must be made by the grantor based on his or her own comfort level and preference.
Another issue to watch out for when forming an income only Medicaid trust is that the term “income” must clearly be defined. When we think of the term “income” generated by trust assets, we usually consider interest and corporate dividends. But under the Internal Revenue Code, at least, a capital gain is also considered income. If a trust provides that it’s “income” can or must be distributed to the grantor, then if the trust sells an asset for a profit, the grantor may be legally entitled to the entirety of that profit, rendering it vulnerable to creditors and Medicaid spend-down requirements.
For example, say that the grantor transfers a house to a Medicaid planning trust and that the house was purchased back in 1981 for $50,000. If the trust sells the house in 2021 for $400,000, it generates a $350,000 capital gain. In a trust that requires its “income” to be paid to the grantor, this may cause the entire $350,000 to be considered the grantor’s assets for both Medicaid and liability purposes. This is not usually a result desired by a client was engaged in Medicaid planning.
This potential problem can be fixed easily enough by stating in the trust that “income” does not include capital gains.
Considerations Involving the Family Home
The rules for residential real estate, especially real estate that serves as the grantor’s primary residence, are a bit different from the rules that apply to other assets. The first important rule is that, so long as a person is residing in a home, the value of the home itself is not generally considered an available resource for Medicaid purposes. This is because the government does not expect a person to sell his or her primary residence to pay for healthcare and so the Medicaid rules do not require such. The same exception applies when the grantor’s spouse is living in the residence, even if the grantor has moved out (such as, for example, to a nursing home).
It should be noted, however, that this exception only applies when the grantor does not have more than $500,000 (or $750,000, in some states) in equity in the house. If, for example, the house is worth $1 million with no mortgage, the difference between the value of the home and the maximum equity allowance will be considered an available resource. If the grantor lives in a state with a $750,000 maximum equity allowance, then she will be considered to have a $250,000 asset, making her ineligible for Medicaid.
Even when the client’s equity is less than the threshold, there is still reason to engage in Medicaid planning to save the family home. Federal law requires that after a Medicaid recipient’s death, the state seek to recover Medicaid spending from available assets that belonged to the recipient. Therefore, even if a person’s eligibility for Medicaid was unaffected by her owning a home (because of the home equity allowance), after her death the state could (and, in fact is required by federal law to) put a lien on the home to repay the government for its Medicaid expenditure. When the home is eventually sold, the proceeds would be used to repay the state.
On the other hand, if the home is transferred to a trust and the recipient waits the five-year period of ineligibility, the home is no longer the recipient’s asset. As such, the state will be unable to put a lien on it and the home will be available to the heirs in its entirety.
One benefit allowed by federal regulation in the case of real estate is the “caregiver child” rule. This rule allows a parent to give his house to his “caregiver” adult child living with him who provides care. This transfer does not subject the owner to a five-year period of ineligibility. Therefore, if a person lives with a caregiver child, Medicaid planning becomes less critical. The client can always wait until she needs long-term care and then transfer the house to the caregiver child. Assuming the client has no other significant assets, she can be immediately eligible for Medicaid and the house is not subject to a state lien after her death.
Medicaid and Medicaid planning trusts are important tools in the repertoire of any elder law attorneys and Medicaid eligibility should be a consideration in many estate plans.