Using Immediate Annuities in Medicaid Planning

Senior couple, with wife using wheelchair and husband standing with his hand on her shoulder.Immediate annuities can be a useful tool to protect the spouse of a nursing home resident who applies for Medicaid. These types of annuities allow the nursing home resident to spend down assets and give the spouse a guaranteed income.

Immediate annuities may not work in every state, so be sure to check with your attorney. (Search for a qualified elder care attorney near you.)

What Is Medicaid?

Medicaid is the primary source of payment for long-term care services in the United States. To qualify for Medicaid, a nursing home resident must become impoverished under Medicaid's complicated asset rules. In most states, this means the applicant can have only $2,000 in "countable" assets. Virtually everything is countable except for the home (with some limitations) and personal belongings.

The spouse of a nursing home resident is known as  the "community spouse.” A community spouse is limited to one half of the couple's joint assets up to $148,620 (in 2023) in "countable" assets. The least that a state may allow a community spouse to retain is $29,724 (in 2023).

A nursing home resident must pay their excess income to the nursing home. However, there is no limit on the amount of income a spouse can have.

What Is an Annuity?

An annuity is a contract with an insurance company under which an individual pays an insurance company a sum of money in exchange for a stream of income. An immediate annuity will provide you with a stream of income right away.

This income stream may be payable for life or for a specific number of years, or a combination of both – that is, for life with a certain number of years of payment guaranteed. In the Medicaid planning context, most annuities are for a specific number of years.

Medicaid’s Transfer Penalty

The spouse of a nursing home resident may spend down their excess assets by using them to purchase an immediate annuity. But if Medicaid applicants or their spouses transfer assets within five years of applying for Medicaid, the applicants may be subject to a period of ineligibility. This is also called a transfer penalty.

To avoid a transfer penalty, the annuity must meet the following criteria:

  • The annuity must pay back the entire investment.
  • The payment period must be shorter than the owner's actuarial life expectancy. For instance, if the spouse's life expectancy is only four years, the purchase of an annuity with a five-year payback period would be deemed a transfer of assets.
  • The annuity must be irrevocable and nontransferable. This  means that the owner may not have the option of cashing it out and selling it to a third party.
  • The annuity has to name the state as the beneficiary if the annuitant dies before all the payments have been made.

How Immediate Annuities Work

Here’s an example of how an immediate annuity might work:

John and Jane live in a state that allows the community spouse to keep $148,620 of the couple’s assets. If John moves to a nursing home and John and Jane have $320,000 in countable assets (savings, investments, and retirement accounts), Jane can take $200,000 in excess assets and purchase an immediate annuity for her own benefit.

After reducing their countable assets to $120,000, John will be eligible for Medicaid. If the annuity pays Jane $3,500 a month for five years, by the end of that time, Jane will have received back her investment plus $10,000 of income. If she accumulates these funds, at the end of five years she will be right back where she started before John needed nursing home care.

Drawbacks of an Immediate Annuity

Given this planning opportunity, many spouses of nursing home residents use immediate annuities to preserve their own financial security. But it's not a slam-dunk for a number of reasons, including:

  • Some states either do not allow spousal annuities or put additional restrictions on them.
  • Other planning options may be preferable, such as:
    • spending down assets in a way that preserves them,
    • transferring assets to exempt beneficiaries or into trust for their benefit,
    • seeking an increased resource allowance,
    • purchasing noncountable assets,
    • using spousal refusal, or
    • bringing the nursing home spouse home and qualifying for community Medicaid.
  • The purchase of an annuity might require the liquidation of IRAs owned by the nursing home spouse, causing a large tax liability.
  • The non-nursing home spouse may be ill herself, meaning that she may need nursing home care soon, in which case the annuity payments would simply go to her nursing home.
  • The savings may be small due to a high income or the short life expectancy of the nursing home spouse. The process of liquidating assets and applying for Medicaid might not be worth the considerable trouble.

In short, the use of this powerful planning strategy depends on each couple's particular circumstances and should be undertaken only after consultation with a qualified elder law attorney.

In addition, those who do purchase immediate annuities need to shop around to make sure they are purchasing them from reliable companies paying the best return.

Finally, couples need to beware of deferred annuities. (With a deferred annuity, you would receive your stream of income starting at a certain point in the future.)

Some brokers will attempt to sell deferred annuities for Medicaid planning purposes, but these can cause problems. While a deferred annuity can be “annuitized” (meaning it can be turned into an immediate annuity), if the nursing home resident owns the annuity, the income stream will be payable to the nursing home instead of to the healthy spouse. Often, the annuity will charge a penalty for early withdrawal, so it is difficult to transfer it to the healthy spouse.

In short, while immediate annuities can be great tools for Medicaid planning, deferred annuities should be avoided by anyone contemplating the need for care in the near future.