Does Your Retirement Plan Protect Your Home from Medicaid Recovery?

A recent U.S. News and World Report listed five major risks for retirement. One of these risks is health problems. If you don’t plan accordingly, the financial costs of healthcare can lead to everyone’s greatest fears — running out of money.

Healthcare Costs Can Erase Retirement Assets

Healthcare costs skyrocket as we age. Even if your insurance company or Medicare covers some of the costs, a couple retiring at age 65 with Medicare will need about $240,000 for uninsured medical expenses, which does not include long-term care expenses. Long-term care expenses can add dramatically to the cost of retirement. A nursing home costs on average $79,935 per year, an assisted living facility costs on average $37,572 per year, and in-home are costs about $19 per hour. These costs result in another retirement risk, running out of money.

Protecting Your Home from Medicaid Recovery

For many retirees, Medicaid planning is necessary to ensure the payment of necessary long-term care services without running out of money. This is particularly true if you have been diagnosed with an illness, and, therefore, the option of long-term care insurance is no longer available.

As states begin to crack down more and more on traditional Medicaid planning, it is important to be more creative in designing strategies, particularly with regard to your home. In many states, including New Jersey, Medicaid considers the home a countable asset unless it is occupied by the community spouse, a child under age 21, a child of any age who is blind or disabled, a child who qualifies as a caregiver, or a sibling who has resided in the home for at least one year and has had an equitable interest in the home for at least one year (the protected class).

However, on the death of the Medicaid recipient, if the home is an Estate asset, the state will assert estate recovery, which means that is any funds expended for the Medicaid recipient will be collected against the estate. If the home is occupied by a member of the protected class, Medicaid will assert estate recovery but will permit the member of the protected class to remain in the property. When the property is sold or on the subsequent death of the protected class member, the estate recovery lien must be satisfied. If the home is owned as tenants by the entirety or jointly with right of survivorship, estate recovery will be asserted in those states that have adopted the broad definition of “estate,” which includes New Jersey.

Transferring the Home Outright

In order to protect the home, parents often transfer it outright to their children. Clients must be aware of the carryover basis by which the parents' cost basis in the home will carry over to the child. If the child lives in the home for a period of two years after obtaining ownership, then the child may satisfy the requirements pertaining to the sale of a principal residence.  Unless the child meets the principal residence exclusion, there will be significant capital gains tax on the sale of the parent's home by the child.

From a Medicaid standpoint, the transfer of the home to a child who is not a member of the protected class is subject to the five-year lookback. The transfer is subject to the Medicaid transfer penalties. If there is a Medicaid transfer penalty, it is calculated by dividing the uncompensated value of the transfer by the statewide monthly average of the lowest semiprivate room rate in Medicaid-certified nursing facilities. In New Jersey, this is currently $10,459.

When property is transferred from parent to child, the casualty insurance policy should also be changed. Insurance companies usually permit the homeowner's policy to remain in effect if the parent reserves a life estate but usually do not permit the homeowner's policy to remain in effect if a life estate is not reserved.

Retaining a Life Estate

A variation of the strategy of transferring a home to a child outright is transferring the home to the child and retaining a life estate or a use and occupancy agreement for the parent. The retention of a life estate usually makes the parent more comfortable in making the transfer. One of the benefits of transferring the home and retaining the life estate is that the Medicaid period of ineligibility is reduced. The transfer is only for the value of the remainder interest.

For example, if an 80-year-old New Jersey person transfers a home worth $500,000 to a child and the divisor is $10,459 per month, the penalty is 34 months. However, if the same parent transfers the home to the child and retains a life estate, the penalty is significantly reduced. The calculation looks like this:

  $500,000               (value of home)

  × 0.5634                  (remainder factor)

  ---------------

$281,705                  (uncompensated value of transfer)

÷ $10,439                 (average cost of nursing home)

 ---------------

      26.9                       Months - Period of Ineligibility

Round up to 27 months.

An additional benefit is that if the home is not sold during the lifetime of the parent, the child will receive a “step up” in basis on the death of the parent.  

Advantages

·       Protects the home after five years

·       Preserves step-up in basis on death.

·       Parent feels as if he has more control.

·       No gift tax return needs to be filed, because it is an incomplete gift for gift tax purposes.

·       Section 121 exclusion can be preserved.

·       State real estate taxes may be able to be preserved.

·       Parent not entitled to any portion of proceeds, if home is sold.

·       Parent not entitled to any rental income, if property is leased.

Disadvantages

·       Loss of control.

·       If state penalizes transfers out of the trust, if income-only trust is used and house is sold during parents’ lifetime, proceeds are effectively “locked up” during parents’ lifetime.

In states where estate recovery is asserted against the probate estate (like New Jersey), the value of the life estate would not be included in estate recovery. Some of the states using the broad definition of an “estate,” including life estates, have taken the position that the value of a life estate at death is zero; other states using the broad definition have claimed that the life estate is valued at the moment before death. At the present time in most instances, New Jersey does not seek a recovery against the life estate.

The disadvantage to transferring the home and retaining a life estate is that if the home is sold during the lifetime of the parent, the parent would be entitled to a portion of the proceeds of sale represented by the value of the parent's life estate (refer to the above example). Receipt of these proceeds of sale would disqualify the parent from Medicaid, because the parent would be over resourced.

Right to Use and Occupy

A variation on the retention of a life estate is to retain a right to use and occupy. Under a right to use and occupy, the parent does not reserve the right to receive rent or any portion of the proceeds of sale. The disadvantage to the right to use and occupy is that there is a complete loss of the Section 121 Exclusion on the Sale of the Principal Residence because all of the proceeds would go to the children who, presumably, would not qualify.  In which case, the entire amount would be subject to capital gains tax.

Power of Appointment

Another alternative to the reservation of a life estate, grantors may reserve a special power of appointment. For Medicaid purposes, the transfer of property when grantors cannot recover the property for their own benefit is a completed transfer.  The special power of appointment is a “personal privilege” and not an interest in property. Therefore, it should not be subject to Medicaid estate recovery. For gift tax purposes, however, the gift will not be complete. In addition, the grantors' reservation of the special power gives them continuing influence over their issue and flexibility to deal with their children's deaths, divorces, or bankruptcies.

This power of appointment may be reserved in trust into which property (such as the residence) and may be transferred.  The funding of the trust triggers the Medicaid lookback period. If the trust is drafted as a “Grantor Trust,” even using a use and occupancy, should the residence be sold during your lifetime the gain would be protected from taxation up to $500,000 under IRC 121.

As highlighted above, there is a great deal to consider when planning for retirement. In order to protect your home and other assets from Medicaid recovery, it is particularly important to be proactive.