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Medicaid and life insurance. These aren’t like peas and carrots. More like oil and water! You may have heard different information about Medicaid eligibility and life insurance. In this article, we dispel the inaccuracies and tell you what you need to know about how Medicaid works with life insurance. More specifically, how Medicaid eligibility for nursing home affects life insurance you own. The quick answer: it really depends. Read on to learn how Medicaid and life insurance interact with one another. We will also answer how Medicaid, nursing homes, and life insurance all play a part. Finally, we give you options for your life insurance policy if faced with a Medicaid spend down situation.
But first, we discuss Medicaid basics and eligibility. This is important so you can see how life insurance ownership affects your Medicaid eligibility.
What Is Medicaid?
Medicaid is a state-administered program designed to assist and provide low-income adults, children, women, elderly, and those who are disabled with health coverage.
However, it is more than healthcare coverage. Consider these programs administered by Medicaid (depends on the state):
(1) Autism services
(2) Dental care
(3) Behavioral services
The states determine Medicaid services, but must follow mandatory benefits established by the Federal government. The Federal government partly funds the state’s Medicaid programs.
Eligibility for Medicaid is not as straightforward as it sounds or should be. The Affordable Care Act, split Medicaid eligibility into 2 groups.
(1) Based on Modified Adjusted Gross Income (MAGI), and
(2) those who are not eligible based on MAGI (ie. Non-MAGI)
Those who are eligible based on MAGI are outside the scope of this article. Nursing home eligibility falls under the non-MAGI category.
For Medicaid to pay for nursing home costs, you must meet an income and asset test. In 2018, the income test was $2,205 per month and the asset test was $2,000. You may know this level as SSI. SSI, or Supplemental Security Income, is payment in addition to the social security payments you’ll receive from your work credits.
This means if you need government assistance, and nursing home costs paid by Medicaid is considered government assistance, you will have to spend down your assets.
Medicaid calls your assets, “resources”. Medicaid has a unique list of what is a resource and what is not.
The link shows what assets do not count towards the $2,000 resource limit.
What does this all mean when it comes to nursing homes? We will show you. Let’s say you have $150,000 in a 401k. You are diagnosed with Alzheimer’s. Your family enrolls you in a nursing home and they immediately apply for Medicaid to pay. Medicaid says, “Nope. You will need to spend down that $150,000 for us to pay.” This scenario is the infamous “Medicaid spend down” process.
Of course, this is an easy example. Moreover, there are tax and estate implications without proper planning. These implications are outside the scope of the article.
Medicaid and Life Insurance
You may be thinking, “How does life insurance play into the Medicaid spend down process?”
Well, this is how.
Medicaid allows you to keep up to $1,500 in cash value in a life insurance policy. Above that, you need to spend down the cash value.
This is an easy example. So, if you have a life insurance policy that contains $55,000 of cash value, you will need to withdraw $53,500 for use on the nursing home costs before Medicaid pays. (Moreover, this does not assume other spendable assets you have.)
In terms of life insurance, this means your policy is essentially ineffective. You’ll have to terminate your life insurance policy.
That stinks, doesn’t it? You paid into a policy all those years. Now the life insurance is used for something other than its original intention.
You have to think what will your surviving family do. If like most families, they don’t have $10,000 to $20,000 for a funeral, let alone yours.
We will talk about solutions in a minute. Not to worry. The fact that you are reading this article now shows you can take care of this now.
The Type Of Life Insurance Matters For Medicaid Purposes
Some good news. Medicaid affects certain types of life insurance.
As you can surmise, the Medicaid spend down process subjects life insurance policies that have cash value. These policies include whole life, indexed universal life, universal life, variable life – any permanent type of life insurance.
This means term life insurance, since it has no cash value, is fine. The problem? Well, if you know term life insurance, you know that premiums are level for a term. After that, most policies allow you to renew the policy each year at a higher rate.
Look at the example below. Let’s say you are a 35-year-old male non-smoker. A $250,000, 30-year term life insurance policy costs a reasonable $866 per year. Look what happens after age 65…
The shape of the premium spend and the increase is similar to that of a hockey stick. Can you pay that amount into your future?
Sure, you may not need $250,000, but you may need some amount of life insurance. Do you want to keep paying a higher amount each year?
That’s the problem with term life insurance. It is not ideal for permanent life insurance needs like burial and funeral needs, estate planning, debt payments, transfer situations, etc.
However, for the purpose of this article, if you have a term life insurance policy, it is not subject to the Medicaid spend down process.
GULs Could Work, Too
Guaranteed universal life (GULs) is another type of life insurance. It is “guaranteed” because of its “no lapse” feature. Without getting into the weeds, you can pay the same premium for 40 years or longer. In other words, GULs allow a termination age like “to age 95”. You can select age 85, 90, 95, 100, and even to age 121.
It is like a super-enhanced term life insurance policy. Let’s use our example above. If you are age 35 and select a GUL with a termination age of 95, you essentially have a 60-year life insurance policy.
So, you pay the same, level premium for 60 years – and have essentially (but not quite) “for life” coverage like other types of permanent policies.
Another feature is that GULs usually do not contain cash value, especially in the later stages of the life insurance. That means the life insurance is not subject to the Medicaid spend down process. Medicaid can’t tell you to use your policy for nursing home costs because it contains no cash!
As you can guess, GULs have a higher premium than a 30-year term, but lower than a comparable whole life insurance policy.
Solutions For The Medicaid And Life Insurance Issue
While these aforementioned solutions are valid, they require some pre-planning and foresight.
I know what you are thinking:
John, this all sounds good, you say. But I have a current permanent life insurance policy, and I need to protect the cash value NOW.
It’s true. You may have a whole life insurance policy or an indexed universal life insurance policy now. Maybe due to age, health, time, money, or needs you just don’t want to apply for a term life insurance or GUL policy. I can understand that.
Good news is that you can transfer the current permanent life insurance policy you have – whether it is a whole life insurance policy or universal life – to a funeral trust or an estate planning trust.
Before we get into the mechanics of both, know that a funeral trust protects the cash value of the life insurance from the Medicaid spend down process.
That’s right. Medicaid can’t force you to use the cash in your life insurance policy to pay for nursing home costs. They can’t touch it. It is completely legal and through us, the set up and application are free.
What Is A Funeral Trust?
To solve the Medicaid and life insurance problem, a funeral trust works nicely.
Just as it sounds, it is a trust.
You may know what a trust is or have an idea. But, there are a couple of types of trusts. One type of trust allows you to maintain control of it. Because of this control, Medicaid and creditors could legally force you to use the value (the life insurance) inside the trust to pay off debts, etc, including nursing home costs.
This isn’t the type of trust used for a funeral trust.
A funeral trust is irrevocable. This means the trust protects the value from Medicaid, creditors, etc. They can’t get at it, can’t touch it, and can’t force you to use it.
Conversely, neither can you.
Once the money is in there, it’s in there. You can’t borrow from it, you can’t change it, nothing…
But, why would you want to change it? The purpose is to prevent Medicaid or the nursing home to use your life insurance policy.
From that standpoint, the funeral trust serves its purpose and rather nicely.
Just as it sounds, the money pays out for your funeral or burial expenses.
For 95% of final expense whole life insurance policies, that is the typical purpose. So, the purpose of the trust remains the same: to pay for your funeral or burial expenses.
Mechanics Of Permanent Life Insurance
To understand how a funeral trust works, you first need to understand how permanent life insurance works. This is important to understand so you understand what Medicaid and nursing homes go after.
Permanent life insurance policies have cash value. This cash value is yours. At every point, your policy is made up of part cash value and part insurance. When you die, the carrier pays the insurance part. The cash, again, is yours.
For example, if you have a $25,000 whole life insurance policy and $10,000 is cash value, $15,000 is the insurance.
Your cash value grows over time. Every year, your policy earns more cash. And, every year, the carrier’s insurance responsibility is less and less. This is for whole life insurance.
Universal life (including index and variable) operates its cash a little differently. Your cash and insurance component are separate, and your cash has the ability to grow independently. However, premiums for universal life (except for the GUL discussed previously) are variable and the carrier may, at some point, require a premium increase for proper funding.
Understand that Medicaid is after the cash value in your life insurance policy, not the insurance component. The cash value is yours, and this is what Medicaid forces you to liquidate upon the spend down process.
The cash is what we want to protect and transfer to the trust.
You may think, “John, I have a whole life policy for $25,000 with $20,000 cash. You mean I can only transfer the $20,000, and not the $25,000?”
Yes, only the $20,000.
You have to remember what we are protecting. Assets. This includes cash value.
Would you want to guarantee the $20,000 protection or have the chance it is wiped out?
Right. You want to protect the $20,000. It is yours.
Transferring Money To A Funeral Trust
Now that you understand the cash value of the life insurance policy, know that we recommend transferring the cash to a funeral trust when the cash/death benefit ratio is 70% or more. On a $10,000 whole life policy, that means around $7,000 cash.
Transferring the cash value is very simple. You simply fill out exchange paperwork and the trust receives the cash value via transfer.
OK, John. Can I transfer anything else?
Yes, you can transfer anything else with value and are in non-qualified tax status. (In other words, money that has already been taxed.) This includes CDs, annuities, monies in a non-qualified brokerage account.
You see, Medicaid goes after all of this for its spend down process. All of these assets are subject to the Medicaid spend down process including life insurance cash value.
Contact us to understand how to transfer CDs, annuities, and anything else as there are potential taxable event situations or penalties.
Nevertheless, transferring money or value, including cash value and other assets, is a rather easy process.
Conversely, you can pay money into the trust as well. For example, you can pay $100 per month into the trust. However, you must fund the trust within 10 years maximum.
With the company we work with, there is no cost for the trust. It is free. Honestly. Moreover, everyone qualifies.
Mechanics Of A Funeral Trust
Now that we know how to transfer money to a funeral trust, how does it work?
It is rather simple. As we mentioned earlier, the purpose of the funeral trust is really to protect assets for your burial and funeral expenses.
The value in the trust grows at a predefined interest rate. Upon death, the value is paid out directly to the funeral home. The payout is income tax-free.
That is it. No worries from your surviving family about how to pay. Moreover, no worries that Medicaid accesses the money because they can’t.
Upon death, your family simply needs to call the trust company. Provide them with the funeral home information and they will send a check to the funeral home.
It is easy.
And, the drawbacks, if any?
Well, one drawback is there are a few states that do not allow this funeral trust. (More on that in a minute). Another drawback is the other 44+ states allow up to $15,000 to be placed into the trust. Some states allow less.
Is this a bad thing?
Not really. Consider that the average funeral cost is around $15,000. Moreover, remember, the trust protects the money from Medicaid among others. See the illustration below.
Another drawback is that any money left over in the trust and not paid to the funeral home goes into your gross estate. State laws differ, but this means the money is subject to probate law. For example, the funeral trust contains $15,000. Your funeral costs $10,000, $5,000 remains in your estate.
Another advantage of the funeral trust is that is can be implemented during a “crisis” situation. Let’s say you have a family member entering a home. You can fund the trust immediately to prevent further spend down.
Estate Planning Trust
A funeral trust has no look-back provision. With asset transfers and Medicaid, currently asset transfers within 5 years of entering into a nursing home are subject to penalties.
With a funeral trust, once the money is there, the money is protected day 1.
How great is that?
However, what if you want to fund more money above your state’s maximum? Or, what if your state does not allow a funeral trust?
Good news. An Estate Planning Trust exists. It operates similarly to a funeral trust. Same protections. The difference?
* you can fund up to $100,000 in combination with the funeral trust
* 5 year Medicaid look-back exists
* money goes to your beneficiaries, not your gross estate
Like the funeral trust, this is irrevocable. Once it is done, it is done. But, think back. What are we protecting here? Your life insurance and other assets from Medicaid. If you have money set aside for your children, say in a brokerage account, the money is subject to Medicaid spend down process. Remember, life insurance is subject to the Medicaid spend down process as well.
The Estate Planning Trust works the same way. The cost of the trust is free. You just need to be aware of the 5 year Medicaid look back for nursing home spend down.
Of course, you don’t have to go this route. But, the options are rather limited. We discussed a few above. There is term life insurance and GUL. These types of life insurance usually are not subject to Medicaid. However, they require pre-planning and good health.
And, let’s say you want to keep that money sitting in the CD or annuity. You just don’t want to bother transferring and protecting the money. What are the drawbacks? Well, there are plenty.
As you can tell, a funeral trust or an estate planning trust works rather nicely when it comes to protecting your assets from Medicaid.
I hope you found this article informative. Yes, you can protect your life insurance from Medicaid and the spend down process. We discussed several ways you could go about this, including a funeral trust and/or an estate planning trust. Both of these trusts protects your assets, including cash value from permanent life insurance, from the Medicaid spend down process.
Don’t know what to do next? Give us a call, contact us, or use the form below. We would be happy to help you.
As with everything we do, we place your best interests first. That means we won’t recommend a funeral trust or estate planning trust if it does not make sense in your situation. Even if there a solution that we can’t provide, we will tell you about it and help you any way we can. This is the only way we know how to work with our clients.