Annuity or Promissory Note?

I'm intrigued with how many lawyers use Medicaid-qualifying annuities when doing crisis Medicaid planning.  Medicaid-qualifying annuities address a core issue in crisis Medicaid planning for applicants with excess resources. The annuity acts as a “spend down,” which often leads to immediate eligibility for the client.  The promissory note has the exact same impact and use in this fact pattern, but interestingly, it is used less often, even though it’s much easier to achieve eligibility, which will disqualify the individual for benefits for a period of time.  The question becomes which to use and why. 

The Omnibus Reconciliation Act of 1993 (OBRA) was the first legislation that began to set parameters for annuities to be Medicaid-qualifying.  Essentially, it requires the annuity to be irrevocable, non-assignable, to have no cash value, and to be payable over the life expectancy of the annuitant.  The Medicaid-qualified annuity rules are further enhanced by the Deficit Reduction Act of 2005 (DRA), wherein it also required that all annuities must have equal monthly payments with no delay in or balloon payments, and the annuity must name the state as the irrevocable beneficiary after the death of the annuitant.  This significantly reduced the use of Medicaid annuities as a spend-down strategy to only married applicants, but it still allows them to be used in a crisis case to become “otherwise eligible” and use the annuity funds to be used for payment of long-term care costs during any disqualification period created by any uncompensated transfer. 

DRA 05 also provided the first legislative permission for Medicaid-qualified promissory notes.  DRA specifically provides that a loan to a third party by a Medicaid applicant will be deemed as a compensated transfer if it is irrevocable and pays over the life expectancy of the applicant.  Essentially, DRA 05 permitted every individual to create a private annuity.  The one risk, however, is that the statute does not require a promissory note to be non-assignable, so if it is assignable, it will be a countable resource in determining Medicaid eligibility because it is saleable and has a value.  To avoid this, ensure that your promissory note is non-assignable. 

So the question becomes, if you can do your own promissory note, why would you ever use a Medicaid-qualifying annuity? 

The answer comes down to your state's application of the DRA 05 laws regarding promissory notes.  While the federal law is clear that they are permissible, some states still don't permit them and count them as an available resource in determining the eligibility of a Medicaid applicant.  This perplexes me, as federal law is clear, and under federal law, the state law cannot be more restrictive than the federal law.  Most states that have taken a position against promissory notes have seen that position overturned by legal proceedings, whereas many states that do not permit promissory notes have not been effectively challenged. 

Notwithstanding, as estate planners we are not litigators, and we strive to avoid litigation.  So if your state does not permit promissory notes, then the path of least resistance is using Medicaid-qualifying annuities.  When given the choice, a promissory note is easier, it can be done within the confines of your own office and it can be customized to the individual needs of the client, whereas Medicaid-qualifying annuities are typically restricted by the minimum period of time required by the insurance companies (typically a 24-month payout).  To learn how to effectively use a Medicaid annuity versus a promissory note, let LWP show you. 

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David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center