Last year, the U.S. Court of Appeals for the Third Circuit handed down an opinion on Medicaid-compliant annuities that could affect Medicaid planners across the nation. The court in Anabel Zahner v. Secretary of Pennsylvania Department of Human Services overruled a Pennsylvania District Court opinion, which left many scratching their heads about the use of short-term annuities. This opinion is only binding in the states covered by the Third Circuit (Delaware, New Jersey, Pennsylvania and the U.S. Virgin Islands), but it’s likely to have far-reaching effects on the use of the Medicaid investment in other states.
Originally, the opinion was based on three families who gifted large sums of money. They also bought short-term Medicaid-compliant annuities for the purpose of paying for a nursing home during the period of ineligibility created from the large gifts. Under federal rules, the annuity should not be considered an asset or resource, and the purchase of the annuity is also considered to be a proper transfer of funds (i.e., a transfer that does not create an additional penalty period). These families did their own version of the modern “half-a-loaf” planning technique.
Modern half-a-loaf planning
Before the Deficit Reduction Act of 2005 (DRA), a common planning technique was to give away half of the client’s assets and use the other half to pay through the penalty period created by the gift, known as the half-a-loaf plan.
When Congress passed the DRA, it took proactive steps to curtail this activity. The principal way of doing so was to change the penalty start date from the date the gift was given until the person who applies for Medicaid is “otherwise eligible.”
Under the DRA, a person would give away approximately half of the assets to create a penalty period when the patient’s resources fell below the state limit. To get them further below the state limit, the remaining half of the assets would be used to purchase a Medicaid-compliant annuity with a term equal to the length of the penalty period caused by the gift. This process is known as the modern half-a-loaf.
These plans are primarily used by people with limited resources to set aside funds for maintaining a home or to enhance the quality of life for the patient with the gifted funds. The penalty periods do not end up being considerably long. Because the penalty periods are relatively short, the annuity term must also be relatively short, which is what the Pennsylvania District Court took issue with.
The Third Circuit wrote an interesting opinion that parses out every major and minor aspect of Medicaid-compliant annuities and reaffirms the viability and use of annuities in Medicaid planning — especially short-term annuities, which is something the district court opinion had ruled against. Here’s what happened:
The annuity safe harbor
The court clearly articulates Medicaid rules have created a safe harbor for resources placed within certain types of annuities. “Congress created a safe harbor pursuant to which certain annuities are not considered resources for purposes of Medicaid eligibility.”
The concept of the safe harbor is something that even a layperson can easily understand. This is a carved-out exception to the rules on what is a countable asset when determining Medicaid eligibility. Congress created the safe harbor rule because it has also implemented rules to encourage people to save for their retirements. By exposing those assets to the threat of a long-term care spend down, Congress has been keenly aware of the moral hazard inherent in such a problem and has also chosen specifically not to provide universal health care coverage for long-term care. So a delicate balance is struck.
Assets can be preserved in the form of an income stream, but that income stream has to be set up with strict, rigid requirements. Such requirements form what we now commonly refer to as the Medicaid-compliant annuity.
Annuities are not a sham
The district court opinion specifically found that short-term annuities were considered to be sham transactions. The court alleged that the annuity term was so short that it was not a real investment, but merely a clever way around the Medicaid eligibility rules.
When overruling the district court, the Third Circuit took a different approach. They evaluated the nature of the investment and found it was a proper investment because it met the general understanding of the term. Additionally, it pointed out that all insurance products are licensed by a state insurance commissioner. These short-term annuities are licensed insurance products and are approved for sale in Pennsylvania and other states. Insurance commissioners do not inherently approve sham investments for sale to the public.