Attorney Timothy P. Crawford, CPA, CELA*, CAP** wanted to share this information with you.

Transcription

1 Attorney Timothy P. Crawford, CPA, CELA*, CAP** wanted to share this information with you. ANNUITIES! THE REST OF THE STORY! WHAT ELSE YOU NEED TO KNOW TO PROTECT YOUR ASSETS! Offices in Racine and Brookfield Crawford, Crawford & Stutt 840 Lake Avenue, Suite 200 Racine, WI Toll Free: (888) (262) Website: By Timothy P. Crawford, Attorney, CPA, CELA* I. INTRODUCTION In this section of the discussion on annuities, we will be dealing with the more advanced topics. These will include: Period of Ineligibility Calculations caused by improper annuities Gift & Spend Strategy vs. Title 19 Annuity Strategy How to Use an annuity inside an IRA How to play the DEATH CARD with a Title 19 Annuity Strategy How to coordinate Long Term Care Insurance with an annuity II. USING THE WRONG ANNUITY It is possible you will come across a situation where someone has annuitized an annuity, and it has been annuitized for longer than the allowable period contained in the MA Handbook Appendix Life Expectancy Tables. To the extent you have annuity payments that exceed the person s life expectancy, you would total up the payments, discount it, and then divide it by $5,484 (figure used for year 2007) to calculate the period of ineligibility. Surprisingly, this period of ineligibility may be very small. CRAWFORD - 1

2 III. INSURANCE COMPANY ANNUITY ALSO REFERRED TO AS A COMMERCIAL ANNUITY The advantage to a Commercial Annuity is you do not have to worry about a child not making payments as required. There are some insurance companies that will annuitize the annuity over a period as short as 3 years. Sometimes you want the annuity to be for the shortest term possible, other times you want it to be for the longest term possible. See the discussion on Length of Annuity in the following section. Once you decide to invest with an insurance company, you then have the option as to the type of annuity. You could purchase either a Fixed or a Variable annuity, which is then immediately annuitized. Be careful in selecting the Variable annuity insurance company. Certain insurance companies may not let you annuitize a Variable annuity immediately. Use of a Variable annuity eliminates the need to comply with the interest rate required by Wisconsin Law for Fixed Annuities. A recent Wisconsin Administrative Law Judge ruling indicated that the commercial Variable annuity used did not comply with Wisconsin Title 19 Law. He stated the annuity s sub accounts were not investments regulated by the SEC, as required by Wisconsin Title 19 Law. The Administrative Law Judge does not understand the Variable annuity product. By definition, all Variable annuities issued by any insurance company will not have investments regulated by the SEC. Instead, they will have investment sub accounts. This is an arrangement made between the insurance company and a mutual fund company, whereby the mutual fund company which is regulated by the SEC will create a mirror image of one of their mutual funds. This mirror image investment (sub account) would mimic or mirror the performance of its mutual fund product. However, the insurance company is not purchasing the mutual fund itself. It is merely hiring the mutual find advisory service to manage the insurance company s investments in the sub account in such a way that the performance of the insurance company s investments (known as sub accounts) will mimic or mirror the performance of the mutual fund company s mutual fund. An investor in an insurance company variable annuity knows when he selects a sub account inside his insurance which is intended to match the XYZ fund, then the performance of his sub account will very closely match the performance of the XYZ mutual fund. In my opinion, this was simply an Administrative Law Judge who did not understand the operation of insurance company sub accounts within a Variable annuity and how they mimic or mirror mutual funds. A second alternative would be that the Administrative Law Judge wanted to reject Variable annuities even though it was obvious the Law was intended to allow variable annuities. The Administrative Law Judge merely locked on to this technical discrepancy between an insurance company s sub account not regulated by the SEC and CRAWFORD - 2

3 a mutual fund which is regulated by the SEC. Obviously, the drafter of the law and the Wisconsin Legislators did not understand this distinction either. This is a distinction without a difference. If you do not purchase a variable annuity, the other annuity investment approach is to purchase a fixed Single Premium Immediate Annuity, also referred to as a fixed SPIA. With a fixed SPIA, the interest rate earned by the Annuity must meet a certain minimum interest rate as required by law. However, many planners have experienced the fact that the Government is not enforcing the minimum interest rate requirements on fixed SPIAs. Although you may find only a 2% return on a fixed SPIA, the Government is not calculating a period of ineligibility based on the shortfall in the interest rate. IV. LENGTH OF ANNUITY A. Longer Term Annuity. The Title 19 Law controls the maximum length of an annuity. We must use the Life Expectancy Table contained in the MA Handbook Appendix. For a single person who is in a nursing home, we generally will use the longest length annuity possible to make the monthly annuity payment as small as possible so as to spend the least amount possible each month on nursing home care. Remember that after Father s death in the nursing home, the annuity payments will continue for the benefit of his children. Some insurance companies will permit a child to take the remaining monthly payments on a discounted lump sum basis. This is called commutation. B. Shorter Term Annuity. In some situations, you want to make the length of the annuity as short as possible. This will make the annuity payment very high. A typical time in which you may want to do this, is where husband is in the nursing home, and you have taken out the Annuity in the name of the wife. Then, as the annuity payments come in, she can either keep the Annuity payments or gift the annuity payments away. If the wife has purchased Long Term Care Insurance, then she may want to retain the funds, as she may not be concerned about spending those funds on her future nursing home care costs. If the wife has not purchased Long Term Care Insurance to protect her assets, then I would gift away the wife s assets. This prevents the wife from accumulating assets, which may cause a problem later if the wife were to enter the nursing home and wants to become eligible for Government Benefits to pay for her stay. CRAWFORD - 3

4 V. IMPACT ON MINIMUM MONTHLY MAINTENANCE NEEDS ALLOWANCE (MMMNA) If you are in a situation where the wife has low income, then some of husband s income could be shifted to the wife and spent by the wife, rather than on the husband s nursing home care. This happens in a situation where the wife s income is less than $2,020 per month (2007), which is the Minimum Monthly Maintenance Needs Allowance (MMMNA). In this situation, where the husband has the ability to shift income to a wife, then how much the monthly annuity payment will be, and for how long it will continue, will be extremely important. In some situations, you will decide to have a shorter length annuity than required, thus, losing or reducing the husband s beneficial shift of his income to his wife for only a very short period of time. The annuitization period may be as short as two years. After this two-year period is up, the beneficial income shift would be greater once the annuity has been paid in full and the annuity has stopped making payments. The other situation is for the payments to be low for a longer period of time, thus, reducing, but not eliminating, the beneficial income shift for a longer time. A calculation must be made each time you want to use the Annuity Strategy, to see whether a shorter or longer length of the annuity will produce the best plan. Obviously, if the wife s income is above $2,020 per month (2007) (MMMNA), then any annuity payment, whether it s small or large, will not result in a reduction in the shifting of the husband s income to the wife, as none of husband s income could be shifted to his wife. I like to think of the annuity payment substituting for the income that could be shifted from husband to wife. In some cases, because of the loss of the beneficial income shift for a long time, the annuity payments do not help you for a long time. VI. USE OF ANNUITIES WHERE FATHER IS A WIDOWER Where Father is a widower and is in the nursing home, using a Title 19 Annuity Strategy is very simple. If the Annuity Strategy is to be used, you will want the annuity payments to be as small as possible. Thus, you will have the lowest amount of Father s money that must be spent on his nursing home care, and thus, get the largest Government subsidy possible. This way the Government will be paying more of his nursing home care, and Father will be paying less of his nursing home care. Father is spending his money slower this way. Obviously, this is assuming that you have decided that Father will not live to his Table Life Expectancy. You always need to compare the Gift & Spend Strategy with the Annuity Strategy. CRAWFORD - 4

5 VII. ANNUITIES AND IRA S We now know because of the KEIP case, that in a spousal setting, the wife would not have to get rid of her IRA when her husband is in the nursing home. However, what can we do about the husband s IRA? When a husband has an IRA and the wife is living in her own home, there are a number of choices with respect to how we can handle the husband s IRA. 1. Husband could cash out his IRA, pay his tax, gift it to his wife, and his wife could hold it as part of their CSRA if the amount is low enough. 2. Husband could cash out his IRA, pay his tax, gift it to his wife, and the wife could then purchase an annuity. This would allow his wife to preserve her entire CSRA and to have annuity payments coming in besides. This needs to be coordinated with the MMMNA to see the impact the annuity would have on income shifting. The Title 19 Annuity Strategy needs to be compared to the Gift & Spend Strategy. 3. Husband could cash out his IRA, pay his tax, then gift it to his wife, and have her enter into a Gift & Spend Strategy. This generally would not be used. A more favorable strategy would be for the husband to be doing the Gift & Spend Strategy and not looking for immediate eligibility, as husband would not need to pay the tax on a lump sum basis, but could spread it out over the length of the Gift & Spend Strategy program. Husband s taxes would be reduced by the payments for his care to the nursing home. 4. Husband keeps his IRA, and husband does a Gift & Spend Strategy. Husband would spend his IRA slowly, while doing a gifting strategy. This would generally be more favorable than for the wife to be doing a Gift & Spend Strategy. See the discussion under paragraph 3 above. Husband can simply keep his IRA. Unfortunately, this would then become part of the CSRA calculation and husband would need to get his assets down under $2,000 by the time of his review date, generally one year after husband had gone onto Government benefits. He can get it down when he needs to by either annuitizing it or cashing it in, paying his tax and gifting it to his wife. CRAWFORD - 5

6 Remember, if the husband is widowed and in the nursing home, the annuitization of the IRA strategy might be used instead of the Gift and Spend strategy. The taxable income which the monthly IRA payments would produce would be nearly offset by the fact that the husband is using those payments to pay for his cost of care in the nursing home. This would be a deductible medical expense on the husband s income tax return. In annuitizing the husband s IRA, we would need to coordinate the annuitization (1) with the Minimum Required Distribution (MRD) under the tax law if the husband is over age 10, and (2) with the Life Expectancy Tables contained in the MA Handbook Appendix. Generally, the MA Handbook Appendix Life Expectancy Tables will produce a lareg enough payment to meet the Minimum Required Distribution payment. This tax liability would be a liability for the husband, which the husband should be able to pay for from his Annuity payment, rather than spending the money on nursing home care cost. XI. USE OF IN THE GAP STRATEGY It is rare, but you will sometimes come across a situation where the Gift & Spend Strategy will not be the best strategy and the Annuity Strategy will produce income so high there will be no subsidy from the Government. However, if the widower s total income is above the rate at which the Government reimburses the nursing home, which I like to refer to as the wholesale cost of care, and below the actual cost of care, which I like to refer to as the retail cost of care, then you have a situation where you are IN THE GAP. When this happens, you will be eligible for Title 19 Government Benefits, however, your subsidy check from the Government will be zero. This still can typically save a client $2,000 per month or more. $1,000 is the approximate difference between the retail cost of care ($6,000 per month) and the wholesale cost of care ($4,000 per month). Sometimes this difference will be larger. In this example, Title 19 will not pay for any medical expenses which they normally would pay for. You will first be required to use your income above the wholesale cost of care to pay for these medical expenses. This is an example of a very creative use of the Annuity. Here we need to do your comparison between Gift and Spend strategy and the Annuity strategy. Then you need to select the appropriate length of the annuity, whether it be short term (2-years) or long term. Then you would need to see how this compares to the retail cost of care and the wholesale cost of care. CRAWFORD - 6

7 XII. USE OF SINGLE PREMIUM DEFERRED INVESTMENT ANNUITIES IN PLANNING WHERE NO ONE IS YET IN THE NURSING HOME You would think if there is no one in the nursing home, you would not need to use the Title 19 Annuity Strategy. Obviously, you would not be using a Single Premium Immediate Annuity (SPIA), nor would you immediately annuitize an existing annuity. You would want to keep more flexibility than the SPIA would provide. You may want to consider recommending to your clients that they begin to assemble their assets. This may even include investing them into an annuity. Generally, this annuity would be either a Single Premium Deferred Fixed Annuity or a Single Premium Deferred Variable annuity. This means the insurance company has their money, but the client can get it back at any time subject to an investment penalty. If the client is under age 59½, it would also be subject to a tax penalty. Accordingly, this strategy is not used for people under the age of 59½, but is reserved generally for people 70 and older, who are concerned about doing planning in advance of going into a nursing home. There are several advantages that annuities can offer. Not only does it provide for tax deferral, you can also have a nursing home waiver which is the right to withdraw money from the annuity to pay for nursing home care costs (as discussed below) and at death a guaranteed compounded rate of return as high as 6% (age restrictions may apply). Many times this will exceed the returns available on alternative investments. By having the money invested inside an annuity the money is all in one place, and very quickly the client can pull the trigger and have an annuitized annuity. My experience has been that sometimes it takes as long as 3 months for a client to assemble their assets and get them invested into an annuitized annuity so as to reduce their net worth to get them below the asset limits. In the meantime, they may be spending $6,000 a month out of their own money paying for their nursing home care. This delay could be eliminated if they assembled their assets in advance. Additional features you may want to have in the Investment Annuity: 1. If you have purchased an annuity in advance as an investment, you may want to make sure that the annuity will contain a feature that would allow you to pull money out of the annuity to pay for nursing home care costs without an investment penalty. 2. You may want the annuity that you have purchased to contain a feature that would allow you to cash in the annuity in full in the event you are in a nursing home without an investment penalty. This would give you the flexibility of moving it from the existing insurance company to an insurance company which may have better features for a Title 19 Annuity. CRAWFORD - 7

8 3. In a Title 19 Annuity you will want the insurance company to offer a feature that allows the children to receive a lump sum from the annuity upon Father s death. This will prevent the children from being required to receive monthly payments, when they would prefer to invest the money, on a lump sum basis, in an alternative investment more suitable for the children upon the death of their Father. XIII. USE OF THE GIFT & SPEND STRATEGY VS. OTHER STRATEGIES Do Nothing Strategy We have been discussing the Title 19 Annuity Strategy as if this was the strategy of choice. However, before you can make that determination, one should always look at other strategies that are available. One strategy which is many times ignored by planners, but may be the ideal strategy, is the Do Nothing Strategy. Father may be in the nursing home on private pay, and that may be the best strategy. This would be true in a situation where Father had highly appreciated assets and is near death. We would want Father to die owning these highly appreciated assets, and get a step-up in basis, and save approximately 20% of Father s assets simply by having Father die owning these assets. This strategy will generally only work if Father is going to die within a 3 month timeframe, has no other assets, and has sufficient highly appreciated assets where the 20% savings will more than offset the cost of paying for his care for 3 months. Gift & Spend Strategy When you are looking to get Father, who is in the nursing home, eligible for Government Benefits, you need to get him below the asset limit. This is generally accomplished in one of two different strategies. The first strategy is referred to as the Gift & Spend Strategy or the Cure Strategy. With the Gift & Spend Strategy, you are trying to bring down Father s net worth to the appropriate level. Typically, the way the math works out on this, you will be gifting Father s money away then spending half of Father s money. You make a large gift intentionally creating a period of ineligibility, while you continue to spend money on nursing home care during this period of ineligibility from the previously gifted monies. To properly advise your client, you need to compare the Gift & Spend Strategy and it s alternative, the Title 19 Annuity Strategy. The advantage to the Title 19 Annuity Strategy is that you can use it to get Father immediately eligible for Government Benefits. Title 19 Annuity Strategy With a Gift & Spend Strategy you will not be receiving an immediate subsidy for Father s nursing home care, as you will need to wait until Father is under assets from the gifting and any period of ineligibility has CRAWFORD - 8

9 expired. Thus, you are giving up the opportunity for a subsidy that you could achieve immediately though the Title 19 Annuity Strategy. To determine whether the Gift & Spend Strategy is better than the Title 19 Annuity Strategy, you need to make some calculations. There are many factors involved, some of which will be unknown at the time you must make your calculations. Accordingly, for these unknown factors you will need to make some assumptions. Generally, the unknown factors will be, when will Father die? When will Father leave the nursing home? Some other factors will include, what are the tax consequences to sell assets and invest them into an annuity? What are the tax consequences to cash out Father s assets so he can gift the cash away? Other Factors An often forgotten factor is the tax advantage to the Gift & Spend Strategy. While Father is in the nursing home the medical expense deduction will almost completely offset the withdrawals from the IRA that are used to pay for his nursing home care costs. Thus, you are able to withdraw his IRA on virtually a no tax basis. Other factors that need to be looked at are the cost of purchasing an annuity. What happens if Father dies and the children want to get the remaining monthly payments in a lump sum? What will be the discounted amount they will receive? Had they not purchased the annuity, they would not have this discount. What happens if Father lives longer than anticipated? This may result in the Title 19 Annuity Strategy, although looking attractive in the beginning, protecting little or no money in the long run. Observation Generally, I find that if Father where to die in the first 15% of his Table Life Expectancy, then the Gift & Spend Strategy, or Do Nothing Strategy would have been superior to the Title 19 Annuity Strategy. I also find that if Father lives longer than 50% of his Table Life Expectancy, the Gift & Spend Strategy generally would have been the superior strategy. In the middle, generally, the Title 19 Annuity Strategy will be better. However, it is necessary to make your math calculations to see what would be the best in your particular planning situation. The decision is not easy. Numerous calculations and assumptions must be made. There are many variables involved in these calculations and assumptions. In addition to Father s monthly cost of care in the nursing home, he will need to consider whether or not there will be any additional out-of-pocket costs for medications, physical therapy, speech therapy, etc. It is not just room and board that you are concerned with, but the total cost CRAWFORD - 9

10 of care. Next, you need to identify all sources of income which could not be eliminated. I refer to these as uncontrollable sources of income. These typically include Social Security and Pensions. They do not include investment income, as investment incomes can be eliminated. If an annuity is to be used as part of the solution, then the monthly annuity payment needs to be taken into account in making the calculations. This is true because of the impact the annuity payments have on the MMMNA. The Annuity payment will be different, depending upon the length of the annuity that you select. Thus, the amount of the annuity payment can be planned. Once these factors are determined, you can begin to calculate and compare the benefits of a Short Term Annuity vs. a Long Term Annuity. Your goal is to estimate the monthly benefit of Father s Government subsidy. The Government subsidy is the amount by which his private pay payment will be reduced once Father is on Title 19 Government Benefits to pay for his nursing home care costs. Remember, if you have received a subsidy from the government, you will need to repay the government that amount at the time of Father s death. When working with annuities, it is important to remember that Father s actual life expectancy is frequently less than the Table Life Expectancy. This is normally true where Father is in poor health, and the table life expectancies are based on averages of all people that are Father s age. However, if Father is in the nursing home with Alzheimer s, and is not otherwise sick, he may outlive his Table Life Expectancy. Anytime you expect Father to outlive his Table Life Expectancy, you would not want to use an annuity in a widower s setting. XIV. SUMMARY From the above discussion, you can see that Title 19 planning is involved and complicated. It is not as simple as some planners want you to believe; that all you need to do is buy an annuity and your problem is solved. We know it is more difficult. Some of your pitfalls and problems are as follows: 1. The annuity you have purchased may have the wrong features. 2. The annuity you have purchased may be from the wrong Company. 3. The annuity that you purchased may not qualify under the Deficit Reduction Act (DRA) requirement. 4. The annuity that you purchased may not qualify under the MA Handbook Appendix Life Expectancy Table. 5. The Title 19 Annuity Strategy may not have been the best solution as compared to alternative strategies available. CRAWFORD - 10

11 6. Maybe you have the wrong owner of the Annuity. 7. Did we fail to consider the purchase of Long Term Care Insurance for the healthy spouse, so that annuity payments would not be lost if she enters the nursing home while she has assets or income coming from the Title 19 Annuity Strategy? 8. Did we fail to recommend Long Term Care Insurance to our clients when they were healthy and able to purchase Long Term Care Insurance? 9. Do you have your Long Term Care Insurance in place so that you will not need to do Government benefit planning in the future? Remember Government benefits my not be there for you in the future. Those Who Plan Ahead Win. Those Who Don t Plan Ahead Lose. This article is not intended as legal advice. It is basic information. I would recommend that you call Attorney Timothy P. Crawford for a free conference to discuss your situation in more detail. Attorney Timothy P. Crawford can be reached toll-free at When you call in, please mention the fact that you have read this article. Attorney Timothy P. Crawford is a Board *Certified Elder Law Attorney. He has been Board Certified by the National Elder Law Foundation which has been approved as the Sole Certifying Organization for Elder Law Attorneys by the American Bar Association. Timothy P. Crawford was invited to join the Council of Advanced Practitioners of the National Academy of Elder Law Attorneys (NAELA) in August of The **Council of Advanced Practitioners (CAP) is a small group of premier elder law attorneys, all of whom have been members of NAELA for at least 10 years, are certified as elder law attorneys by the National Elder Law Foundation, and are AV rated by Martindale Hubbell. OFFICES IN RACINE & BROOKFIELD Helping Families in Wisconsin for Over 30 Years to Protect Their Assets from Nursing Home Care Costs Copyright by Attorney Timothy P. Crawford. This document can be used without the advance written permission of Attorney Timothy P. Crawford however you must disclose the fact that Attorney Timothy P. Crawford is the author.. TPC/jms/DATA-TPC/MARKETING FORMS/ARTICLE-ANNUITIES-NO DELLS/ REVISED 12/29/03 1/5/04 2/22/08nmm CRAWFORD - 11

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