January 26, 2022 – Life presents us with many challenges (a.k.a. problems) that can be solved with strategies that, while completely legal, may not be aligned with our moral compass. The definition of a moral compass has two elements: 1) the ability to determine what is right and wrong, and 2) to act accordingly. Using your moral compass is most helpful when directions are given, and the path is not very clear in most situations.
We know that managing our finances can be confusing. Many rules and regulations guide effective strategies. Some are straightforward, but many are difficult to understand and even harder to execute. As Financial Life Guides, we are well-positioned to help our clients navigate these complexities and guide them to well-informed decisions. What if actions are qualified under the rules and are considered legal, or at least defensible, but yield an unintended outcome?
Recently, the financial press caught wind of a Roth IRA strategy employed by an investor, Peter Thiel, who turned a $2,000 investment in his Roth IRA into a $5 Billion account which will compound returns and allow withdrawals without any tax liability. A legal strategy for sure, but one that prompted Congress to consider changes to the rules to close an outcome that was never intended. Avoiding tax on a $5 Billion investment; how does that affect your moral compass given the wealth inequality in our society?
Government regulations that underpin the IRS Tax Code and the various social programs (Welfare, Social Security, Medicare, and Medicaid) provide a ripe environment for self-serving interpretations contrary to the program’s intended spirit. How do you feel about using food stamps to buy alcohol, tobacco, lottery tickets, guns, or to attend adult venues? If any of these alter your moral compass, don’t move to Arizona!
We have previously written about the vital theme of healthcare planning and the difficulty many Americans find in taking full advantage of healthcare programs provided by Federal and State governments. Medicaid is an entitlement afforded to low-income families, pregnant women, and children, and Medicaid is the single largest source of healthcare in the United States. Eligibility for this social program mandates your income from all sources must be below $2,523 per month and “countable assets” no greater than $2,000. Eligibility requirements vary by state, and the rules become very complicated when there is a “non-applicant” spouse.
Medicaid planning has been considered by many who do not currently qualify for benefits because current health insurance coverage, including Medicare, does not cover costs related to long-term care provided by nursing homes or other institutionalized locations. While prices of nursing home care vary by region and accommodation type, potential costs in today’s dollars can approximate $100,000-$150,000 per year with an expectation that long-term care (either assisted living or nursing home) would last 4-5 years. Depending on longevity and type of illness, costs of care could approximate $1 million. This uncertain future “liability” would not be considered affordable by most elderly Americans. If a long-term care event does materialize and insurance is not in place to help fund the cost, the usual avenue would be to pay for expenses out of personal income and assets until your financial situation would allow for Medicaid eligibility.
Since Medicaid, unlike Medicare, is a means-based program, Medicaid planning contemplates an orderly “spend-down” of assets and income until benefit eligibility. While gifting assets to family members would reduce asset levels, an application for Medicaid benefits includes a “look back” period whereby a penalty is determined that is equal to any assets transferred for less than the market value during the five years immediately before the application is filed. Any transaction can be scrutinized, no matter how small, and there is no exception for charitable giving or gifts to grandchildren. Informal payments to a caregiver may be considered a transfer for less than fair market value if there is no written agreement, as would a loan to family members.
There are exceptions for transfers during the look-back period, as you would expect. Exempt recipients include a spouse or trusts for the sole benefit of a blind or disabled child or any disabled individual under age 65. There are also special exemptions that apply to a transfer of a home.
When complex rules allow for exceptions, there is an opportunity for “smart” people to figure out legal ways around the rules. In the case of Medicaid eligibility and look-back period penalties, there are a few strategies that can be employed:
- Shifting assets and income to the non-institutionalized spouse.
- Purchasing certain types of assets that are considered “non-countable” by Medicaid.
- Transferring a home to a child who is either under age 21 or considered a “caretaker” child who lived in the house for at least two years before institutionalization and provided care that allowed the applicant to avoid a nursing homestay.
A strategy employed by some high-net-worth individuals wishing to shelter assets from exposure to long-term care costs is to set up an irrevocable trust to benefit individuals who would otherwise be beneficiaries of their estate. The trust would be funded with assets equal to the excess of what the applicant would be required to keep to support their ongoing lifestyle, including an estimated cost of a five-year stay in a nursing home. In simple terms, this is how this strategy would work:
Assume a single individual with $2 million of assets is concerned that their hard-earned assets, intended to be left to family members at death, are exposed to the cost of long-term care. Also, assume that the individual believes that the assets they would need to fund their future lifestyle (above income provided social security and pensions) are $300,000. A five-year stay at a good nursing home would amount to $500,000. An irrevocable trust could be set up for the benefit of family members with $1.2 million of assets leaving the individual with $800,000 to fund their lifestyle and sufficient assets to pay the Medicaid penalty should there be a medical necessity within the next five years. When appropriately structured by eldercare professionals, this arrangement would be legal and allow for sheltering a significant amount of assets.
The difficulty most individuals face in this situation is two-fold:
- Do I want to give up control and access to my money? Do I trust my family members to support me, if needed, with only a “wink and nod” arrangement in place?
- Is this strategy ethical? Does it affect my moral compass?
These are personal questions that only the individual can answer. And despite being able to help our clients develop strategies aligned with their objectives, understand the complex factors inherent in the execution of a plan, and pledge our fiduciary duty to act in their best interests, the ultimate decision is uniquely theirs.