The Crackdown on Medicaid Planning

New government rules require creative strategies to protect your assets.

Warning: Stricter Medicaid rules may derail your strategies for protecting your family's wealth. That's because Congress has stiffened the penalties for giving away money so that your parents are able to qualify for government-paid nursing-home care.

Opportunity: Take time now to review estate plans for both you and your parents. With proper preparation, you can ensure your plans are still effective despite longer waiting periods before Medicaid will pay for long-term care.

The back story: Medicaid, which is jointly funded by federal and state governments, is intended to provide health care for the poor. But it has also become the major source of financing for long-term care, paying nearly half of all nursing-home bills after residents run out of money. Most states require nursing-home residents to spend virtually all of their assets -- down to as little as $2,000 -- before they may qualify. Married couples have higher asset allowances as long as one spouse is healthy enough to remain at home.

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A year in a nursing home costs about $75,000 nationwide (substantially more in the Northeast and California), so it's easy to wipe out a lifetime of savings. You can sidestep the Medicaid issue by buying long-term-care insurance if you or your parents are healthy enough to qualify for coverage and can afford the premiums. A policy that provides coverage for five years of care at $143 per day with inflation protection costs about $2,000 a year or more, depending on your age.

For some individuals, long-term-care insurance may not be an option. And some people give away their money and property in order to qualify for Medicaid help sooner, a practice known as Medicaid planning. One way to deal with both situations is to earmark funds sufficient to pay for care, then establish an irrevocable trust to remove remaining assets from the estate, says Barbara Culver, president of Resonate, a wealth advisory service in Cincinnati. But Medicaid planning, always a touchy subject, has become even dicier since Congress enacted new rules to crack down on such tactics.

Tougher restrictions. The government doesn't want to finance long-term care for people who are sheltering assets that could go toward paying their bills. So the new rules, which took effect in February 2006, extend the "look back" period from three years to five. If an individual gives away money or property during the five-year look-back, it triggers a penalty period during which he or she is ineligible for government aid.

The penalty period equals the amount given away divided by the average cost of nursing-home care in your area. So, for example, if you give $60,000 to family members and a nursing home costs $6,000 a month where you live, you can't qualify for Medicaid for ten months.

Under the old rules, the penalty period was less onerous because it began the day you transferred the assets. That meant it often expired before you were admitted to a nursing home, so you could still qualify for government aid when you applied.

Now, however, the penalty period begins the day you apply for Medicaid, which by definition means you have already spent virtually all of your money and need public assistance to pay the bills. (Asset transfers made before February 8, 2006, are grandfathered under the old rules.) That means the family members who receive your gifts may have to pay nursing-home bills during the penalty period until you qualify for Medicaid.

Creative solutions. Since the new rules took effect, Jennifer Cona, an elder-law lawyer in Melville, N.Y., says she has seen a stream of clients who are "kicking themselves because they didn't plan earlier." Says Cona, "We've had to become more creative."

Cona is setting up irrevocable trusts so that clients can shelter their assets and continue to live in their homes or receive income (but not principal) from the trust. Under the old Medicaid rules, trusts were subject to a five-year look-back period, compared with three years for other asset transfers. Now that the five-year look-back period applies across the board, the added protection of a trust is more appealing.

If the client needs long-term care before the five-year look-back ends, Cona explains, beneficiaries of the trust may take an advance on their inheritance or sell the house to raise cash. If the client doesn't need care until after the five-year window closes, the trust assets are protected and the client is eligible for Medicaid as soon as remaining unprotected assets are spent.

For those who need immediate care, Cona sometimes drafts a "caregiver agreement," under which a parent agrees to pay an adult child for caregiving services, such as driving to medical appointments, helping with household chores and coordinating or providing care. The payments help draw down the parent's assets closer to the point of Medicaid eligibility while passing cash on to a family member, who may have to take leave from his or her job to become a caregiver. Because the payments are considered wages rather than gifts, they avoid the restrictions on asset transfers. Such wages must reflect current rates for local home-health-care aides (the average wage is about $19 an hour nationwide), and the recipient must pay taxes on the income.

Don't jump in. Even though many adult children are willing (even eager) to help their parents deal with long-term-care bills, it's often better to wait, recommends James Ryan, of Lenox Advisors, in New York City. If you intervene too soon, all of your financial gifts will be considered your parent's assets and will go toward paying nursing-home bills.

And don't let your parent take out a home-equity loan to pay long-term-care bills, says Ryan. Up to $500,000 of home equity ($750,000 in New York and some other states) is excluded from assets used to calculate Medicaid eligibility. Once your parent qualifies for Medicaid, he says, you can be as generous as you like with gifts and cash.

Remember, though, that Medicaid is not an ideal solution even if you can protect some assets. "Medicaid comes up short in protecting your freedom of choice," says Ryan. You or your parent would probably have to go into a nursing home to receive government-financed care, rather than remain at home, which most people prefer. As a result of the tougher Medicaid rules, Ryan says, more people are interested in buying long-term-care insurance.

Mary Beth Franklin
Former Senior Editor, Kiplinger's Personal Finance