I recently had a potential client call me up and state confidently – “I need Medicaid, but I know I won’t qualify because I have a large amount of money saved in my 401(k).”
It is true that qualified retirement accounts such as a 401k, Individual Retirement Account (IRA), or SEPs are usually large assets. It is also true that 401k’s and IRAs are deemed a countable asset by Medicaid which, without proper Medicaid planning by an elder law attorney, would likely prevent someone from being eligible for Medicaid.
The goal of every elder law attorney that handles Medicaid planning cases is to take countable resources and turn them into non-countable resources in accordance with Medicaid law and regulations. So, how do elder law attorneys do that with a sizable 401(k) or IRA?
How to turn a 401(k) or IRA into an asset that is exempt or non-countable by Medicaid?
As a quick review, in Florida, Medicaid will not be offered to someone who has more than $2,000 in countable assets or grosses more than $2,349 per month in income (from all sources of income combined) as of January 2020 (the medicaid income test changes periodically). Elder law attorneys who engage in Medicaid planning have a variety of strategies to choose from depending on what asset(s) and income sources they need to protect.
With a 401k or IRA, there are two options to choose from:
(1) Put the 401k or IRA in Payout Mode
At the right time, just before the application is submitted, coordinate with the financial advisor or holding institution to put the retirement account into payout status, taking the required minimum distribution (RMD). If this is done properly, then Medicaid will not count the IRA or 401k as an asset. This strategy must be crafted carefully, because you cannot just start taking withdrawals in any amount, you have to take RMD per IRS life expectancy charts for tax purposes. IRS instructions for how to calculate required minimum distributions can be found by clicking on the link. However, to complicate things further, DCF (Florida Medicaid) has a different life expectancy table used to determine whether the RMDs are "actuarially sound," which is required for Medicaid to not count the qualified retirement plan as an asset.
This solves an asset problem (the IRA or 401k is no longer counted as an asset by Medicaid), but creates an income problem. Now that the retirement account is paying out per the RMD, the Medicaid applicant now has an extra source of income. The income will then need to be protected through establishing a Qualified Income Trust (also known as a Miller Trust or d4B Trust).
If the Medicaid applicant is younger than 59 ½ then there will likely be additional IRS tax consequences on the early withdrawal. While my firm will never render tax advice (we will have you consult with your tax professional, or happily refer you to one), the penalty is roughly 10% plus the additional income-tax burden (so you pay 10% on the amount withdrawn in addition to any income tax that would ordinarily be due on the withdrawal anyway). There is an IRS waiver of the 10% penalty upon showing a total and permanent disability by the IRA or 401k account owner and a series of substantially equal payments.
No one likes paying more taxes then they need to, but the savings realized when Medicaid pays for a huge portion of expensive long-term care costs usually makes the extra tax liability worthwhile.
What if I am not old enough to qualify for "required minimum distributions"?
Luckily, Medicaid does not have an age requirement to turn a qualified retirement account (such as an IRA, Roth IRA, 401k, etc..) into a non-countable resource. Florida Medicaid only requires that the Florida Medicaid Waiver or ICP applicant take regular distributions. We normally advise our clients to take the equivalent of a required-minimum distribution regardless of age, unless cashing out makes more sense.
Understand that taking any distributions if under 59.5 may result in an IRS-mandated tax penalty. You and your Florida elder care attorney will discuss whether the benefit of receiving Medicaid outweighs the tax-penalty.
(2) Cash out the 401k or IRA
The other way to turn the 401(k) or IRA into a non-countable asset – is to make the asset disappear and liquidate the account. Your elder law attorney would then be able to shelter the assets with a spenddown strategy, special needs trust, Medicaid compliant annuity (or some combination thereof).
Again, if the Medicaid applicant is looking to withdraw from the funds early, there may be a 10% penalty in addition to whatever they have to pay in income taxes on the new sources of income.
New Complications with the SECURE Act of 2020
President Trump has signed a spending bill that makes major changes to retirement plans. The new law is designed to provide more incentives to save for retirement, but it may require workers to rethink some of their planning.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act changes the law surrounding retirement plans in several ways:
- Stretch IRAs. The biggest change eliminates “stretch” IRAs. Under current law, if you name anyone other than a spouse as the beneficiary of your IRA, the beneficiary can choose to take distributions over his or her lifetime and to pass what is left onto future generations (called the "stretch" option). The required minimum distributions are calculated based on the beneficiary’s life expectancy. This allows the money to grow tax-deferred over the course of the beneficiary’s life and to be passed on to his or her own beneficiaries. The SECURE Act requires beneficiaries of an IRA to withdraw all the money in the IRA within 10 years of the IRA holder’s death. In many cases, these withdrawals would take place during the beneficiary’s highest tax years, meaning that the elimination of the stretch IRA is effectively a tax increase on many Americans. This provision will apply to those who inherit IRAs starting on January 1, 2020.
- Required minimum distributions. Under prior law, you have to begin taking distributions from your IRAs beginning when you reach age 70 ½. Under the new law, individuals who are not 70 ½ at the end of 2019 can now wait until age 72 to begin taking distributions.
- Contributions. The new law allows workers to continue to contribute to an IRA after age 70 ½, which is the same as rules for 401(k)s and Roth IRAs.
- Employers. The tax credit businesses get for starting a retirement plan is increased and the new law makes it easier for small businesses to join multiple-employer plans.
- Annuities. The newly enacted legislation removes roadblocks that made employers wary of including annuities in 401(k) plans by eliminating some of the fiduciary requirements used to vet companies and products before they can be included in a plan.
Which 401k or IRA Medicaid Planning Option is Better?
The potential benefit to cashing out and paying the income tax penalty is that the proceeds can be sheltered whereas most of the income generated by the RMD option will likely have to go to pay the patient responsibility portion of the nursing home bill. If the person qualifying for Medicaid is expected to live a long time, liquidating the retirement account is likely preferable because the sheltered money can be used to improve their quality of life (Medicaid doesn’t pay for everything).
However, if the life expectancy of the Medicaid recipient is not long, it would be to the Medicaid recipient’s heir’s benefit to leave the 401(k) or IRA in RMD payout mode, even with all the income going to the nursing home. This is because after the Medicaid recipient passes away, the beneficiaries would then be entitled to the remaining amount left over.
This takes careful planning, and certain steps need to be taken in a very specific order. I would try to dissuade anyone from taking any action until they have a comprehensive Medicaid-planning strategy laid out for them by a qualified elder law attorney.
Elder Care Lawyer Resources
Equal Monthly Distributions Exception to 10% Early Withdrawal Excise Tax
Disability Exception to 10% Early Withdrawal IRS Excise Tax
4. Florida Medicaid Life Expectancy Tables: http://www.dcf.state.fl.us/programs/access/docs/esspolicymanual/a_14.pdf
5. Florida Medicaid Manual Section.1640.0505.04 Retirement Funds: http://www.dcf.state.fl.us/programs/access/docs/esspolicymanual/1630.pdf
Again, our firm does not render tax advice. The tax consequences will need to be discussed with your financial adviser, CPA or other tax planner. A referral to the appropriate tax specialist can be provided upon request.