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Think Twice Before Forfeiting Financial Independence

person with short, white hair seen from behind sitting at a table in a coffee shop

You might expect a guru to advise you to give away all your material wealth for your spiritual benefit. But in many cases, you are just as likely to receive that advice from an elder care attorney.

My colleagues and I have seen multiple instances in which a local elder care lawyer suggests that an affluent individual give away a substantial portion of his or her assets specifically in order to secure Medicaid assistance with long-term care expenses. The idea is that such drastic action will prevent a scenario in which long-term care costs exhaust the individual’s own assets to a point where the person’s heirs inherit nothing.

In some cases, such planning can make sense. But almost none of those scenarios involve starting with a high overall net worth. Giving the assets away well in advance of care will indeed ensure heirs receive the intended assets, but it can have substantial downsides.

Consider Jane, a healthy 70-year-old with a house worth $600,000, an individual retirement account worth $700,000 and a taxable brokerage account worth $700,000 (for a total net worth of $2 million). She lives in a relatively expensive part of the United States and does not plan to move soon, if ever.

The first question Jane should consider is whether she is likely to need long-term care at all. The Department of Health and Human Services found that about half of Americans who turned 65 in 2016 will eventually need some form of long-term care, though the majority will need assistance for less than two years. About one in seven adults in this population will need care for more than five years, and around 37 percent will receive care in facilities (rather than in their own homes).

Averages can’t predict the future, and your own family history and health may make care more or less likely for you. But these numbers are large enough that it is wise to make some plan for the possibility you may need some type of care for at least a few years.

Nursing homes or other long-term care facilities are often inarguably expensive. Details such as the area of the country, the level of care and the quality of the facility itself can all affect the overall price tag. But Genworth Financial Inc.’s online calculator provides some ballpark figures: adult day care averaged $18,200 per year in 2017; assisted living cost an average of $45,000 annually in the same period. Nursing homes, which provide the most intensive level of care, could run between $86,000 and $97,000 per year depending on the level of privacy. If, like Jane, you live in an area with a high cost of living, these amounts may run higher.

Medicaid is a major means by which Americans pay these expenses. According to calculations from the Center for Retirement Research, Medicaid covered 31 percent of long-term services for adults 65 and older in 2012. But the primary question with Medicaid is not what it pays for, but who qualifies. The specific rules vary by state, but usually family size, net worth and income play a large role in determining whether individuals qualify for coverage.

For nursing home care and other facility-based long-term care options, Medicaid will only pay on behalf of individuals whose assets are limited. This is the foundation of the Medicaid planning strategy of giving away a large chunk of assets in advance.

For institutional care, the planning must also account for the five-year “look back” period. If the program determines that someone applying for such care gave away assets in the five years prior, it assesses a penalty period. The particulars are determined by state law, but generally the applicant will face a number of months during which Medicaid will not pay, based on the size of the gifts. There are a few exceptions that will not trigger the penalty, but these are very limited by design.

Jane spoke with a lawyer who suggested putting her home into an irrevocable trust in order to ensure an inheritance for her adult children. If Jane later sold her home, all the proceeds would go into the trust. However, in order for the trust to be effective for Medicaid planning, trust assets could not benefit Jane directly. The trust could build in a provision to give the trustee discretion to use the trust assets to purchase a new home in order to give Jane a place to live, but Jane would have no control over the precise details of this process.

Effectively, Jane would be giving up her financial freedom by taking this step. In the area where Jane lives, $1.4 million is not as much as it sounds like if you divide it over 20 years or so, in a scenario where Jane reaches her early 90s. This is especially true when you consider that half of these assets have not yet been taxed.

The traditional idea behind Medicaid planning is even more extreme than Jane’s case. The classic way forward is for an individual to part with all of his or her assets, usually including a primary residence. He or she generally expects the heirs to help meet living expenses in exchange, but this means giving up most or all financial freedom in the meantime, something few adults in good health will relish.

Medicaid planning in this way not only means giving up financial independence while you are in good health, but it means you will be restricted to long-term care facilities that Medicaid will pay for should you need institutional care. And if you happen to become ill or experience disability before the five-year look back period has passed, you will be without assets of your own and potentially without Medicaid support, too.

Say that Jane is unlucky, and becomes seriously ill in the near term. If she did place her house in an irrevocable trust as her lawyer suggested, Jane still has $1.4 million in assets. Even if she pays $100,000 annually – the high end of estimated nursing home care costs – the average stay in a long-term care facility is only about two years. This means she would not come close to applying for Medicaid’s assistance. In an unusually bad scenario, Jane would need to spend 14 years at the most expensive level of care to wipe out her assets entirely. This is not impossible, but it would be highly unusual.

The truth is, with proper planning, individuals with between $1 million and $5 million in assets will face a lot of downside for limited upside in traditional Medicaid planning. For people with net worth above $5 million, it is deeply unlikely long-term care could ever exhaust assets completely, even if the need for care is acute and extended. This sort of planning makes no real sense in their situation.

None of this is to say that anxiety about long-term care costs is unfounded or foolish. I know from experience that personal history can often shape our emotions about these sorts of decisions. I watched Medicaid planning backfire for my grandparents, whose financial situation was much more modest than Jane’s.

My grandfather was seriously ill at a time my grandmother was still healthy; they decided to give the majority of their assets, including their house, to my mother and my uncle. Sadly, my grandfather died very shortly thereafter, without ever going into a long-term care facility. My grandmother lived for years after, still in good health. When she eventually sold the house, she faced a substantial and unnecessary tax bill. This is because the capital gains tax includes an exclusion for home sales when they are the owner’s primary residence, but my grandmother was no longer the owner. In the end, neither of my grandparents used Medicaid, but my grandmother lost her financial independence and relied on gifts from her adult children to pay her bills for the rest of her life.

My grandparents could not have known how their decision would play out, and in their financial situation, their approach was not entirely illogical. But it highlights the risks of Medicaid planning for those of modest means – and those risks are even more acute for more affluent individuals.

Though Medicaid planning is not a useful way forward for many people, that doesn’t mean you should ignore the impact long-term care might have on your plans to pass wealth to your children or other heirs. It also does not mean you should turn to long-term care insurance. My colleagues at Palisades Hudson have written on multiple occasions about the faulty logic underlying the product, and many companies have stopped writing new policies in recent years. Genworth, one of the largest remaining players in the space, recently secured state regulators’ approval to raise costs an average of 58 percent on some policies.

To the extent you don’t need your assets for yourself, you can make smaller lifetime gifts to your heirs – not to qualify for Medicaid, but to ensure they get what you intend regardless of your future long-term care costs. Such gifts will only pass assets you intended to bequeath regardless and, unlike paying long-term care insurance premiums, any remaining assets will be available for whatever other expenses you face if you are lucky enough to never need care.

The best solution for most people who want to be sure their heirs inherit regardless of long-term care costs is whole life insurance. If you intend to use a life insurance policy primarily to pass on wealth to your heirs, it is wise to set up an irrevocable life insurance trust. Structured properly, a trust will protect the policy’s benefits from Medicaid recapture and federal estate tax, if the latter affects your situation. Even in a scenario where you spend down all or most of your other assets on long-term care, your heirs will be guaranteed an inheritance as long as you keep up with premium payments.

Traditional Medicaid planning can work, in certain situations, for working- or middle-class families. But high-net-worth individuals can expect to take on a lot of risk and potential downside for little benefit.

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