To start, I believe that you have been given faulty information about whether the 401(k) account is a countable asset now as far as Medicaid is concerned. Unless this plan is different from every other one I’m aware of, your brother can withdraw the funds any time. He would just be subject to an excise tax if he did so before age 59 ½ (with some exceptions). However, some states don’t count any assets until age 65 as long as the applicant is not living in a nursing home. A local elder law attorney or the state Medicaid agency could advise you on how this works in Iowa. To find an attorney near you, click here.
Assuming the funds do become countable at age 59 ½, they can be spent for your brother in all of the ways you suggest. In fact, there’s no limit on his spending the money. He could even take a vacation or buy a boat. He cannot, however, give the funds away. In addition, as you suggest, your brother can transfer the funds into a limited kind of trust known as a first-party or (d)(4)(A) trust, referring to a statutory exception to the usual trust rules. The biggest drawback of this trust is that if any funds remain after your brother’s death, they must go to the state to reimburse it for its Medicaid expenditures on your brother’s behalf. In addition, your brother cannot create the trust himself. It can, however, be created by either of your parents if they are alive – a reason you may want to set up the trust ahead of time. An elder law or special needs planning attorney can advise you on this.
Be aware that both spending down and transferring the 401(k) funds is a taxable withdrawal.
Finally, Congress recently passed the so-called ABLE Act, which permits people to set aside up to $14,000 a year in sheltered accounts. The law as ultimately enacted was so limited that I’m not aware of any financial institutions that have created them yet. But that should change over the next 13 years.