The effectiveness of using promissory notes under the Deficit Reduction Act's (DRA) new rules was a topic of lively discussion on the ElderLawAnswers DRA listserv last week. A Rhode Island member started things off by asking how promissory notes can be employed and what the point would be if the state can recover any assets held in the decedent's probate estate anyway.
Several list members outlined the general concept, which is similar to the pre-DRA half-a-loaf planning: a parent makes a gift to a child of a portion of the excess resources, and loans the balance to the child via a promissory note over the time period created by the gift. A Medicaid application is made in the month of the gift. The loan payments when combined with the parent's other income should be just under the income threshold for Medicaid ineligibility. The child uses a portion of the gifted proceeds to pay the difference between the parent's income and the cost of care during the penalty period the gift created. After the penalty period has run out, the child should still have some of the gifted money left.
The discussion then turned to the relative advantages of the annuity vs. the promissory note route, as well as the "reverse gifting" technique. A Pennsylvania practitioner pointed out that annuities bring in a third party (the insurance company), making it easier to argue that the annuity stream can't be converted to a lump sum, and that he also has the benefit of the recent Richman decision. But the promissory note route has its own advantages: it's less expensive to implement (no commissions, etc.) and easier to undo if the plan doesn't work or the family decides not to fight the state. Also, while there is a secondary market for annuities if they are not structured properly, there is no secondary market for unsecured promissory notes.
There was difference of opinion on the advisability of including in the promissory note a standard clause that the borrower may pre-pay the loan without penalty. The idea is that each month the borrower would pre-pay on the loan in an amount that, when added to lender's other income, would be almost enough to pay for the full cost of lender's care. However, some expressed the concern that such a prepayment clause would invalidate the loan under the DRA's requirement that "[p]ayments must be made in equal amounts during the term of the loan." But an Ohio practitioner reported that he discussed the terms and conditions of a planned promissory note with his state Medicaid agency, and a prepayment clause did not encounter objections.
How does the promissory note approach compare with reverse gifting with no annuity or promissory note involved? Under the reverse gifting approach, a gift of all the assets is made, with a portion returned in cash to the Medicaid applicant as a partial cure, allowing the applicant to spend down this lump sum to pay for care until the penalty on the original gift, less the amount returned, runs out. One commentator saw this as untested and "too risky" at this time, and is doing it only in cases where the family has already made uncounseled gifts.
Massachusetts attorney Harry Margolis sees two advantages to promissory notes over reverse gifting: First, there's no question about a partial cure being accepted. Second, it may be less likely that the recipient of the gift refuses to cure. "At least if he does," Margolis said, "the attorney is less likely to be held liable for abetting a fraudulent conveyance since the attorney set up a plan which included a legally enforceable right of repayment for the client."
A participant asked whether promissory notes in Medicaid planning were actually working anywhere. Experience is scant, but a New Jersey practitioner reports that while he and others in his state have had success, still others "have experienced complete inaction on the part of Medicaid and anticipate litigation."
The entire Listserv exchange, which began Jan. 16 and continues sporadically, can be found in the January 2007 archives. Note: This and the links listed below are available only to ElderLawAnswers members. For information on membership, click here.
If you're not already benefiting from the DRA Listserv, you can join by clicking here.
Promissory note forms can be found in the ElderLawAnswers Knowledge Bank:
- for the form used by The Farr Law Firm, Fairfax, Virginia, click here.
- for the form used by Margolis & Associates, Boston, Massachusetts, click here.
- for the form used by the Law Offices of Stanley M. Vasiliadis, Bethlehem, Pennsylvania, click here.
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