Spousal Annuities

An Old and New Planning Option

Annuities are one of the oldest and most widely used tools for retirement, long-term care, and Medicaid planning Annuities can be thought of as reverse life insurance policies. Where life insurance protects against the risk of death, traditionally annuities were designed to protect against the risk of outliving an individual’s funds.

Annuities, at their core, are investment vehicles designed to accumulate funds and then convert those funds into an income stream that lasts until a defined event. The conversion is called annuitization. There are many different types of annuities, but the focus of this article is on annuities that have been annuitized. That means that the accumulation or cash value has been converted into an income stream.

Medicaid basics

Paying for long-term care in a nursing facility is expensive, ranging from $5,000-$10,000 per month depending mostly on the geographical location. The individual must either privately pay for his care or access Medicaid. In our community, one year of basic nursing home care will cost the couple around $100,000. The threat of impoverishment looms large at these prices. That is why in 2015 a full 60 percent of Tennessee nursing facility residents were enrolled in the Medicaid program. Tennessee Medicaid’s CHOICES program provides funds to pay for care in the nursing facility, as well as through home- and community-based options.

Of course, Medicaid is a public benefit program, so applicants must meet financial and medical qualifications in order to be enrolled in the program. As to assets, the law provides a certain amount of protection a community spouse can retain to prevent complete impoverishment. There are certain exempt assets for qualification purposes: the homestead, one vehicle, most personal property, a pre-paid funeral and burial plan, and (sometimes) the community spouse’s retirement account.

Then the countable assets are valued, regardless of which spouse holds legal title, to obtain a total. A Resource Assessment is used to set amount of the couple’s countable assets and thus the amount of assets that must be spent down. It is often produced on the first day a spouse is institutionalized for 30 consecutive days.

For 2017, the community spouse may retain one-half of the countable assets up to $120,900. This is called the maximum Community Spouse Resource Allowance (CSRA). The minimum CSRA is $24,180. The remaining assets are allocated to the spouse with a disability and must be spent down to $2,000 before he will qualify for Medicaid.

Income is treated differently. The community spouse may retain all of her income while the majority of the institutionalized spouse’s income is used to offset the cost of his care. However, if the community spouse’s income is less than the minimum Monthly Maintenance Needs Allowance (MMNA), which is $2,003 for 2017, then the Medicaid agency may allocate part of the institutionalized spouse’s income to the community spouse so that her total gross income is equal to $2003 per month. The community spouse can keep more of the institutionalized spouse’s income if it is found during a fair hearing that the spouse is suffering “exigent circumstances causing significant financial duress.”

Why is an annuity helpful to protect the community spouse from impoverishment?
We have seen that Medicaid treats assets and income very differently. The community spouse’s income is not subject to Medicaid limits, spend-down, or patient liability. Medicaid compliant annuities can be used to create an income stream for the community spouse. The use of an annuity helps by creating a monthly income stream to help her pay her bills without the need for a fair hearing.

Because of the ability to convert assets to income, the use of Medicaid qualified annuities has proven to be a contentious subject. The Deficit Reduction Act of 2005 placed strict restrictions on which annuities are to be considered Medicaid compliant. Among other restrictions, the value of a non-Medicaid compliant annuity purchased during the five-year look back period is considered a gift.

In addition, courts have differed significantly as to whether the annuity can be funded with the assets that must be spent down. For example, in McNamara v. State Dep’t of Human Services, 744 N.E.2d 1216 (Ohio Ct. App. 2000), an Ohio circuit court held that after a spouse is institutionalized, 42 U.S.C. §1396r-5 limits transfers to annuities for the benefit of the community spouse. The court held that transfers to the community spouse are limited to the maximum Community Spouse Resource Allowance, and that the community spouse may not use an annuity to spend down the institutionalized spouse’s share of the countable assets.

Hughes v. McCarthy

Many courts and Medicaid agencies, including TennCare, followed and expanded McNamara’s reasoning. However, the line of reasoning espoused in McNamara, when applied to pre-eligibility transfers, was overturned by the Sixth Circuit Court of Appeals in Hughes v. McCarthy, 734 F.3d 473 (6th. Cir. 2013), another case from Ohio. In that case, Mrs. Hughes entered a nursing home in 2005. The couple privately paid for her nursing home care for almost four years, largely using Mr. Hughes’ individual retirement account (IRA).

In June 2009, Mr. Hughes purchased a $175,000 immediate single premium-annuity for himself with funds from his IRA. (Note that if he lived in Tennessee, his IRA would have been a exempt resource as long as he was taking monthly withdrawals.) After the Deficit Reduction Act of 2005, in order for an annuity to be Medicaid compliant it must be irrevocable, non-assignable, paid in equal installments with no deferred or balloon payments, be actuarially sound, and the state providing Medicaid benefits must be designated as a beneficiary up to the amount paid for the institutionalized spouse’s care. Actuarially sound is generally held to mean that the term of payments has to equal the actuarial life expectancy of the annuitant.

Mr. Hughes’ annuity paid him $1,728 per month for nine years, a period commensurate with his actuarial life expectancy. The annuity named Mrs. Hughes as the primary beneficiary, and the state of Ohio as the contingent beneficiary for the total amount of medical assistance paid for Mrs. Hughes’ care.

Mrs. Hughes applied for Medicaid coverage in September 2009. In December 2009, she was approved for Medicaid as of the day of application. However, the agency determined that the annuity purchase was impermissible, because it was purchased with a community resource that exceeded the CSRA and the Ohio agency was not named as the first beneficiary. She was deemed eligible for Medicaid, but subject to a penalty period of just over a year before she could receive Medicaid nursing home benefits.

Mr. and Mrs. Hughes appealed, but the state prevailed in the administrative action and in the state trial court hearing. The Hughes filed a 42 U.S.C §1983 claim with the federal district court, stating that the agency had violated federal Medicaid law. The Hughes argued that §1396p(c)(2)(B)(i) allows them to purchase an actuarially sound, immediate, single-premium annuity for the sole-benefit of the community spouse.

The federal district court granted summary judgement to the Ohio Medicaid agency. Hughes v. Colbert, 872 F. Supp. 2d 612 (N.D. Ohio 2012). The district court based its ruling on the McNamara line of reasoning. In particular, the district court relied on a Western District of Oklahoma case, Morris v. Oklahoma Dept. of Human Services, 758 F. Supp. 2d 1212 (W.D. Okla. 2010). In Morris the court ruled that 1396r-(5)(f)(1) precludes pre-Medicaid eligibility transfers to the community spouse in amounts that exceed the CSRA, because the supersession clause in effect trumps the transfer provision of §1396p(c)(2)(B).

Mrs. Hughes appealed the decision to the Sixth Circuit Court of Appeals. Unknown to the courts, the Centers of Medicare and Medicaid Services (CMS) had written letters to several state agencies stating that the reasoning in McNamara was incorrect when applied to transfers made prior to applications for Medicaid. However, the Hughes court was not advised of the letters. At this point, the National Academy of Elder Law Attorneys (NAELA) provided an amicus brief that included copies of the CMS letters for judicial notice. The NAELA brief provided additional weight when the Ohio Bar Association added its support.

After receiving the NAELA brief, the Sixth Circuit Court of Appeals requested that Health and Human Services (HHS) file an amicus brief. HHS complied, and the resulting brief provides an excellent and thorough insight into their understanding of the interplay between the CSRA and spousal annuities. As to the central question, the court found the HHS brief credible, and afforded it respect.

In the meantime, the Tenth Circuit Court of Appeals decided Morris v. Oklahoma Department of Human Services, 685 F.3d 925 (10th Cir. 2012). That court overturned the district court’s ruling on very similar facts to Hughes. The Hughes court explicitly adopted the reasoning of the Tenth Circuit Court of Appeals in Morris.

On appeal, the Sixth Circuit court considered the interplay of §1396r and §1396p(c) on pre-eligibility transfers, stating: “The primary issue on appeal is whether the transfer of a community resource to purchase an annuity for the community spouse's sole-benefit, which transfer is done after the institutionalized spouse is institutionalized but before the institutionalized spouse's Medicaid eligibility is determined, can be deemed an improper transfer under 42 U.S.C. § 1396r-5(f)(1), even though § 1396p(c)(2)(B)(i) allows a transfer of assets “to another for the sole-benefit of the individual's spouse.”

The court held that the provisions of 42 U.S.C. §1396r-5(f) and §1396p(c)(2) operate in different temporal periods. Section 1396p(c) governs penalties for certain transfers of assets during the look-back period before the Medicaid application. 42 U.S.C. §1396p(c)(2)(B)(i) and (ii) provide an exception to this scheme when the transfer is between spouses, or the transfer is to another for the sole-benefit of the individual’s spouse.

In contrast, §1396r-5(f) addresses the Community Spouse Resource Allowance. That statute allows an institutionalized spouse to transfer assets to the community spouse up to an amount equal to the CSRA. The court found the provision’s language about timing dispositive: “The transfer under the preceding sentence shall be made as soon as practicable after the date of the initial determination of eligibility, taking into account such time as may be necessary to obtain a court order under paragraph (3). 42 U.S.C. 1396r-5(f)(1) (emphasis added) The HHS brief described this rule as a “clean up provision” that allows an institutional spouse who has qualified for Medicaid to change title of CSRA assets to the community spouse after approval, but before the eligibility reassessment. For example, the provision allows the removal of the institutionalized spouse’s name from a joint account after approval.

Because the two provisions apply to different temporal periods, the provisions are not in conflict and there is no supersession. The Sixth Circuit court joined the Tenth Circuit Court’s analysis by incorporating the following quote from Morris:

“‘To avoid rendering § 1396p(c)(2)(B)(i) superfluous, we agree that it and §1396r-5(f)(1) must be read to operate at distinct temporal periods: one period during which unlimited spousal transfers are permitted, and one period during which transfers may not exceed the CSRA.’… When assets are transferred ‘to the individual's spouse or to another for the sole-benefit of the individual's spouse,’ 42 U.S.C. § 1396p(c)(2)(B)(i), before the institutionalized spouse is determined eligible for Medicaid coverage, ‘the unlimited transfer provision of § 1396p(c)(2) controls, and [a] transfer penalty [is] improper [under § 1396r-5(f)(1)].’” (internal citations omitted).

The court noted that the legislative history supported their opinion. A Senate amendment to the bill enacting §1396p(c)(2)(B)(i) would have subjected the unlimited transfer provision of 1396r-5(f)(1) to the CSRA transfer cap. However, the House offered substitute language that dropped the reference to the CSRA cap. The House language was adopted.

May a spousal annuity be used as a “spend down” tool?
There could be an argument about what constitutes the “initial determination of eligibility”, and whether the funds can be used as part of the Medicaid spend down. Utilizing McNamara, various courts used the institutionalization date or the request of a resource assessment as the date at which the spousal transfer was limited to the CSRA.

In Morris, the Tenth Circuit Court of Appeals was explicit that the purchase of a qualified annuity can be used as a spend-down tool. The court stated: “In an effort to “spend down” their excess resources, the Morris's purchased an actuarially sound annuity payable to Mr. Morris.” Morris v. Okla. Dep't of Human Servs., 685 F.3d 925, 928 (10th Cir. 2012). While noting that this is an “exploitation” that can only be called “a loophole,” the court stated:

As the federal agency charged with administering Medicaid has noted, a couple may convert joint resources — which may affect Medicaid eligibility — into income for the community spouse — which does not impact eligibility — by purchasing certain types of annuities. This result is not dependent on the CSRA provisions, which provide an independent basis for sheltering certain resources. In other words, a couple may purchase a qualifying annuity payable to the community spouse in addition to the community spouse's retention of the CSRA. We further hold that §1396r-5(f)(1)’s limit on spousal transfers applies only after a state agency has declared the institutionalized spouse eligible for Medicaid benefits.

The Hughes court agreed with and explicitly adopted the Morris court’s holding.

Does the spousal annuity satisfy the “sole-benefit” rule?
The Ohio agency also argued that the annuity fails to comply with §1396p(c)(2)(B)(i)’s sole-benefit rule, because the annuity named a contingent beneficiary. They argued the annuity was not for the sole-benefit of the community spouse because the institutionalized spouse and the state of Ohio are named as contingent beneficiaries and could profit from the annuity.

The Sixth Circuit dismissed this argument. The court noted that the agency’s argument defied Ohio’s own regulations, which require the state be named as a contingent beneficiary. It further noted that no financial product could meet the proposed test, and that it is nonsensical to discuss a sole-benefit requirement after the individual has died.

Importantly, the court noted that “sole-benefit” is not a defined term in the statute. However, the court agreed with HHS that sole-benefit means that annuities must be actuarially sound and all payments made to the community spouse during his lifetime. To be actuarially sound, the duration of the annuity payments must be based on the community spouse’s life expectancy. The court did not explicitly state how an annuity ensures that all of the payments must be paid to the spouse. However, annuities that are non-assignable and non-transferable would seem to pass this test.

What are the requirements for the beneficiary designations on a spousal annuity?
Perhaps the most revolutionary, underreported, and controversial section of Hughes details when the state has to be named the remainder beneficiary of a community spouse annuity. It is the author’s understanding that TennCare requires the state to be named as the first beneficiary of a spousal annuity irrespective of the following.

42 U.S.C. §1396p(c)(2)(B):

(c) Taking into account certain transfers of assets …

(2) An individual shall not be ineligible for medical assistance by reason of paragraph (1) to the extent that—

(B) the assets—

(i) were transferred to the individual’s spouse or to another for the sole-benefit of the individual’s spouse,
(ii) were transferred from the individual’s spouse to another for the sole-benefit of the individual’s spouse,

42 U.S.C. §1396p(c)(1)(F):

(F) For purposes of this paragraph, the purchase of an annuity shall be treated as the disposal of an asset for less than fair market value unless—

(i) the State is named as the remainder beneficiary in the first position for at least the total amount of medical assistance paid on behalf of the institutionalized individual under this subchapter; or
(ii) the State is named as such a beneficiary in the second position after the community spouse or minor or disabled child and is named in the first position if such spouse or a representative of such child disposes of any such remainder for less than fair market value.

As noted above, the court found that the sole-benefit rule of §1396p(c)(2)(B) allows pre-eligibility transfer of assets to purchase annuities for the sole-benefit of the community spouse. The Sixth Circuit held that annuities transferred for the sole-benefit of a community spouse do not have to satisfy §1396(c)(1)(F)’s requirement to name the state as the first beneficiary. The analysis resolves around the structure of §1396p(c)(1) and how both provisions relate to it.

The first paragraph of §1396p(c) (paragraph 1) details the penalty scheme for gifts and transfers for less than fair market value. The annuity requirements of §1396(c)(1)(F) are an integrated part of the paragraph 1 penalty scheme. The provision begins, “For purposes of this paragraph, the purchase of an annuity shall be treated as the disposal of an asset for less than fair market value....” Thus, §1396(c)(1)(F) is designed to treat the purchase of annuities without the state named in the proscribed beneficiary position as a transfer for less than market value.

This is different than §1396p(c)(2)(B) (i), which is an exception to the entire §1396p(c)(1) penalty scheme for below market transfers. Section1396p(c)(2)(B) (i) begins, “An individual shall not be ineligible for medical assistance by reason of paragraph 1 to the extent that …” Therefore, if a transfer meets the sole-benefit test, it is exempted from all other requirements under the paragraph. The annuity does not have to name the state as the contingent beneficiary, because a transfer for the sole-benefit of the community spouse is already exempt from the penalties.

The Ohio agency argued that this reading of the statutes would render the annuity beneficiary requirements a nullity. The court responded by stating, “§1396p(c)(1)(F) is not rendered illusory. It applies to all annuities not excepted by another provision such as §1396p(c)(2) (B), including annuities benefiting non-exempt children or a spousal annuity that is not actuarially sound.”

The court apparently knew that this interpretation could be controversial. It ended the opinion with the following quote: “We have stated time and again that courts must presume that a legislature says in a statute what it means and means in a statute what it says there. When the words of a statute are unambiguous, then, this first canon is also the last: judicial inquiry is complete.” If Congress prefers the interpretation that applies §1396p(c)(1)(F) notwithstanding §1396p(c)(2)(B)(i), it need only amend the statute.”

Interestingly, 42 U.S.C. § 1396p(e) states that an applicant must disclose the purchase of all annuities, and also mentions that the state must be named as contingent beneficiary. At first blush, this would seem to create an issue with the court’s analysis, because the sole-benefit of the community spouse rule is not an exception to §1396p(e).

However, the Hughes court addressed this question in a footnote. Footnote 15 states that §1396p(e) explicitly limits itself to annuities subject to §1396p(c)(1)(F). This is held as proof that §1396p(c)(1)(F) only applies to some annuities, otherwise there would be no limitation, “Thus, subsection (e) reeinforces [sic] the conclusion that §1396p(c)(1)(F) does not control all annuities.”

Potential legal changes

There is no question that the holding of the Hughes Court has been quite unpopular with state Medicaid agencies who will likely try to amend or distinguish the rule. Ohio repeatedly attempted to overturn the ruling, and other courts have attempted to distinguish it. However, those efforts have so far come to naught.

A bill has been submitted that would substantially change spousal annuities. On January 3, 2017 H.R. 181 was submitted to the Committee on Energy and Commerce. The bill would treat 50 percent of annuity income distributed solely to the community spouse as income to the institutionalized spouse. In effect, this would allow half of the income to be utilized by the community spouse while the other half would be used to increase the institutionalized spouse’s patient liability.

At the time of this writing, the bill is still in committee with an uncertain future. However, its progress should be monitored closely. In addition, the bill serves to underscore the fluidity of this rule and, indeed, of all Medicaid rules.


Glen A. Kyle GLEN A. KYLE practices elder law with Monica Franklin & Associates LLC in Knoxville. His practice is focused on long-term care planning, estate planning, special needs trusts, Veteran’s benefits planning, Medicaid/TennCare/CHOICES planning, advocacy and appeals. Kyle is a Murfreesboro native and earned his bachelor of arts in History from Rutgers University. He graduated with honors from the University of Memphis Cecil C. Humphreys School of Law, where he was the business editor of the University of Memphis Law Review.

A similar, expanded version of this article was published in a past issue of the TBA Elder Law Section newsletter, and is available at www.tba.org/newsletter-archive/elder-law-section/2015/elder-law-section07-28-2015.htm.

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