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Financial Tricks And Traps In VA And Medical Planning With Trusts And Annuities

By Jack E. Stephens, Esq. (7/20/2012)


Part 1

The VA pension benefits for vets and spouses are a valuable source of funding for assisted living and home care, especially the aid and attendance benefit. Unlike Medi-Cal, these pensions are designed to benefit in these settings rather than in a nursing home.

Planning for these benefits requires close scrutiny of what is being offered and the steps to qualification. Also, future medical requirements need to be taken into consideration, especially future Medi-Cal, (Medicaid in other states). Most planners recommend that vets and/or their spouses undertake significant transfers of assets to qualify for the benefits. In Medi-Cal planning, transfers of assets has certain limitations, restrictions, and penalties. But under present law, the VA does not take transfers into consideration in administering the benefits. This may or may not be an advantage in VA planning as we shall shortly see.

Like any other situation, there are knowledgeable prudent advisors and there are the unscrupulous in this area of planning. It is highly important that you screen a proposed advisor and obtain references as many are only attempting to sell annuities as part of the planning. Annuities can be a great advantage in VA planning under present law if structured and implemented correctly.

Transfer of Assets

The VA looks at the total value of your estate for valuation. If the total value exceeds about $80,000, excluding the home, you will probably fail the asset value test. The test depends on your life expectancy, projected future needs and estate value. Your financial advisor may recommend that you transfer a portion of your assets to get into the $80,000 range. So, who do you transfer to? You could transfer assets to your children, right? So what's happening to many kids today? They are spending time in bankruptcy court to obtain debt relief; hanging out at courthouses for a little divorce proceeding; or bobbing up and down like a cork with a house underwater. Will they welcome that transfer of assets from you? Absolutely. Will they make those assets available to you when you need them in the future after you qualify for the VA pension? Think about your answer really hard and try not to fool yourself. I'll just leave that response to you.

So, if you don't transfer to your kids, or have no children, where are you going to transfer those assets which exceed the $80,000?

Your financial advisor has the answer - an Irrevocable Trust. What kind? Irrevocable. Can I, personally, get my assets out of such trust in the future you ask? No. Can you retain any powers over the Trust? No. Can you arrange to receive the income from the Trust? No. You mean those assets and income therefrom are gone forever you ask? Not necessarily. What does that mean? It means you better know what the heck you are doing and know that financial advisor and his/her attorney buddy who is drafting that Trust knows what they are doing. If you don't, and they don't, the bad news is that you may be trapped without those transferred assets and no VA pension. The good news for you is that you may have an excellent malpractice suit in the making!

Part 2: The Irrevocable Trust and Tax Consequences

You just followed your financial advisor's advice and transferred your assets to an irrevocable trust. Good move? Maybe. Depends on how the trust is technically drafted. First, let's discuss the Irrevocable VA Trust from hell. It's drafted as a Grantor Trust and allows income to be paid to you, also known as an Income Only Trust. Since you have irrevocably transferred your assets away, excluding your home, you no longer have any control over such assets. Oh, but you are getting the income from such assets. How do you think the VA feels about that? Their feelings were expressed in 38 C.F.R §. 3.276 (b) which includes "all rights of ownership." Any rights, retained to income from property transferred to a Trust will cause the entire value of the property transferred to be countable to the vet (or spouse) for purposes of the VA's asset limit. What does this mean? Pull up a chair, you're gonna need it. This means that the assets you transferred to become VA eligible, will still be counted by the VA, even though you no longer own them. I'm not done with your ugly surprise. Additionally, because the attorney arranged a Grantor Trust, you will be taxed on all of the income generated by the assets although they are no longer yours, irrevocably.

Ok, let's take another scenario. The attorney drafted the Trust so that you retained no powers, whatsoever, but made it a Grantor Trust (meaning the Grantor, that would be you, would pay the taxes rather than the Trust).

How is that going to work for you? Well, for one thing, you will probably pass the asset limit test since you retained no powers to the income. Congratulations, but when the Trust generates income, who pays the income taxes? Got a mirror handy? That's right, since the Trust is drafted as a Grantor Trust, you, as Grantor, are responsible for the taxes. So, now you are paying taxes on assets you no longer own with a limited value VA pension.

So what could come of this situation? Could it affect your VA benefit qualification? Yes, it can! Here's how. The income generated in the Trust is reported on your form 1040 because it's a Grantor Trust. The VA can tap into the IRS form 1040 records and determine, rightly or wrongly, that you are reporting income on assets that you never reported for the asset test. There are now two issues. You are reporting income which may well reduce your VA benefit and the income is being generated from assets the VA was never aware of for the asset limitation. Sounds like Trust from Hell #2.

Ok Jack, "throw me a life line, I'm going under," you shout. What is recommended to avoid this mess?

First of all, utilize professionals who know what they are doing. If I were the attorney, I would draft a Non-Grantor Trust for assets that did not include the home. As a result, you as the Grantor will not be taxed on the income from assets transferred to the Trust. You have exactly NO powers over the Trust and ZERO powers to receive income. May the Trustee have discretion to pay you a little, itsy bitsy, pennies of income? No!!

You are done with these assets and the income generated - period. Can I have a deal with my kids to gift me some of that income back in the future, you inquire. I knew you were going to ask me that, so I'm prepared and I will answer you like this. Last May 2011, the VA added a provision to its manual which prohibits the practice of having the transferee of the assets received from the veteran, return property or income from the property back to the veteran. VA adjudicators are actively enforcing this provision by asking the veteran and the donee of the assets to confirm that any income generated or property received is not being utilized "to pay any of the vet's expenses." My intuition tells me that you can't just say "honest Abe" that its not happening but probably involves a perjury oath which is sworn to by both parties.

If we are considering an Irrevocable Trust for Medi-Cal planning, I utilize a MIDGIT (Medi-Cal Intentionally Defective Grantor Irrevocable Trust). This is a Grantor Trust in which the home is transferred to protect it from liens and claims by the state. The Trust is designed as a Grantor Trust for tax benefits to the parent/Medi-Cal applicant. Should the home be sold, the parent can take advantage of the §121 capital gains tax exclusion. Additionally, the Trust, if properly structured, will allow a step-up in basis for beneficiaries of the Trust on the death of the parent as well as avoiding Medi-Cal claims and liens.

Part 3: Use of Annuities in VA Planning - The Good, the Bad, and the Ugly

Annuities have been utilized for years in VA planning. The annuity is structured so that very low payments are made in the early years of payment with a balloon payment at the end. It is structured this way so the vet can pass the income and asset tests to qualify for the greatest amount of pension. For example, lets say Sarge wants to apply for a VA pension. He owns $180,000 in stock, which is rendering dividends of $7,200 in income per year. If he sells $100,000 of stock and transfers this amount to an annuity, he has reduced his asset value from $180,000 to $80,000, which is normally an acceptable amount. The $100,000 in the annuity becomes an immediate income stream which is not a countable asset for the VA. The annuity is structured so that a very minimal amount ($100 or so) is paid out monthly which is countable for the VA income limit. All income to the Vet is figured so as to reduce or negate the amount of the VA pension. Presumably, Sarge will live for several years at home or in assisted living receiving his VA pension. After his death, the balloon payment is then paid to his designated beneficiaries and everyone lives "happily ever after," well, with the exception of Sarge. The objective of providing Sarge with his VA pension and preserving inheritance for his heirs has then been attained.

But what happens should Sarge no longer be a good candidate for home-care or assisted living? If his condition now requires nursing home care, what issues might we encounter? At least one glaring problem is that balloon annuity. Oh yeah, the advisor that sold Sarge that annuity forgot to tell him that the annuity is irrevocable and unamendable. If that's the case and Sarge feels the need to apply for Medi-Cal, what will be the response? Denied! That's right, Medi-Cal will not even entertain the thought of a balloon annuity because it violates their rules and regulations. Sarge is out of luck.

Could an annuity be utilized for Sarge in another way from the outset? Yes. The annuity could have been structured based on equal monthly payments for a term that does not extend beyond Sarge's life expectancy. The annuity must be irrevocable and non-transferable. Additionally, the good state of California must be made the primary beneficiary should Sarge die before the annuity pays out in total. This type of annuity has no balloon feature as discussed in the VA arrangement. It will create larger payments of income which tends to reduce the amount of VA pension. But without the balloon it is a positive for Medi-Cal qualification. Sarge and other Vets must be aware of these differences when planning for long term care should the VA and/or Medi-Cal be a consideration.

New Annuity Kid on the Block

Because of the problems encountered with applying for Medi-Cal with an annuity designed for VA qualification, some insurance companies offer a new type of annuity in order to satisfy Medi-Cal requirements should a vet later wish to apply for such benefits. Lets use an example to demonstrate the benefits.

Sarge is living in an assisted living facility and desires to obtain a VA pension. He has too many assets to qualify so he sells the excess assets and purchases a single premium immediate annuity which is revocable and assignable. It also allows him to change beneficiaries. Sarge knows that he may have to go to a nursing home in the future, thus, he wants to make sure the annuity will eventually qualify for Medi-Cal benefits.

The initial annuity is setup with a balloon payment to reduce the amount of payments which are considered income by the VA. This will allow for a VA pension with greater benefits, as income reduces the pension dollar for dollar. As situated, this annuity qualifies for the VA but not Medi-Cal. Sarge receives payments for 3 years from the annuity after qualifying for the VA pension. At this time it is determined that Sarge must be transferred to a skilled nursing facility and apply for Medi-Cal. Sarge then exercises the flexibility in the annuity as follows:

1. He converts the balloon payment arrangement to a level pay annuity;

2. He elects to designate the state of California as the primary beneficiary of the annuity;

3. He also elects to make the annuity irrevocable and unassignable;

As a result, the annuity will now qualify for Medi-Cal benefits.

It is important that your financial advisor is aware of these new annuity products which will qualify for both the VA and Medi-Cal. If you don't know a financial advisor, my office can refer you to one who is well qualified to arrange such annuities. Also, if you have a trusted advisor who is not familiar with these annuities, we will be happy to provide information and/or resources to such advisor so that you may obtain proper planning.

We are also available to create proper Irrevocable Trusts for VA or Medi-Cal planning to avoid the catastrophic issues presented in this article. We look forward to consulting with you or your financial advisor in this regard.

Remember - P.P.P. - Planning Prevents Procrastination.

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