01/01/09  HOT TOPICS: EFFECTS OF DEFRA AND DEFRA PLANNING Effects of DEFRA The Deficit Reduction Act of 2005 (DEFRA) has now been adopted into California law as predicted. What does it mean and how may it affect you? The new law impacts an individual’s assets, severely restricts transfers and targets the home for reimbursement of any MediCal payments made to a recipient. There are exemptions and safe harbors under the law which may be utilized. However, to properly secure these advantages you should amend your Trust and implement them into your estate plan voluntarily. Should you fail to take this action your only recourse would be to petition the Court for redress and request that the Court allow you to utilize transfer and exemption strategies which the Court may or may not allow. Obviously, the latter plan is a more time consuming an expensive road to take with no assurance of satisfaction. Let’s take a look at a typical hypothetical client and see how this law works. Ozzie, age 75, and Harriet, age 70, have been married for forty-five years and have two sons. Harriet has some limited long term care insurance but Ozzie has none. They own a home valued at $800,000 free and clear. They have investments valued at $700,000 last year in Fidelity which have declined to $525,000 in December 2008. The potential for a continuing decline is forecasted for at least another six months. Ozzie has an IRA valued at $100,000 and Harriet has a 401k plan valued at $80,000. Each have a life insurance policy of $100,000 in value with a cash value of $20,000. Ozzie receives $3,500 a month in pension and social security. Harriet receives $650 per month in social security. Ozzie’s family has a history of dementia and longevity. His father died at age 89 and his mother died at age 95. Both of them required extensive nursing home care for their dementia. Ozzie has experienced some episodes of forgetfulness and confusion. However, he has not been diagnosed with any particular disease. Harriet is in good health. The couple have been making gifts of $12,000 to each of their five grandchildren in December the past eight years for educational purposes. They intend to make another annual gift in December of this year but are concerned about the financial market. They visit the Law Offices of Jack E. Stephens to determine what they need to do to update their estate plan in light of DEFRA. On review of their family Trust which was initiated in 1998, there were numerous defects. There was no provision for catastrophic illness in which both spouses would agree for all Trust assets to be transferred to the non-ill spouse should one of them suffer a catastrophic illness. The couple also learned that they could enter a Post-Nuptial Transmutation Agreement to effect a transfer of community property to the separate property of the non-ill spouse which would include the home. All non-retirement investments would also be included in the transmutation. On review of their Durable Powers of Attorney (DPA) it was also determined that those documents provided no authority over their individual retirement plans. As a result of the document review Ozzie and Harriet realized they had absolutely no protection from DEFRA should one of them become catastrophically ill. What would happen if they did no planning and Ozzie became ill, long term, from dementia? First of all, Harriet would be allowed a Community Spouse Resource Allowance (CSRA) of approximately $104,000. These assets would be sheltered from spenddown. Presumably she would designate this amount in their non-retirement Fidelity account of $525,000. The balance of this account would be subject to spenddown for Ozzie. So would the cash values in their life insurance policies which amounts to $40,000 between them. Harriet would have $461,000 to spend for Ozzie’s care and their necessities until it was spent down to $2,000 which is the amount Ozzie can exempt for MediCal eligibility. The home and the retirement funds would be exempt from countable assets. Harriet would then apply for MediCal for Ozzie since they are down to the eligibility limits of $2,000 for him and $104,000 for her CSRA. However, on application for MediCal in the year 2013 it is determined that the couple made a gift of $60,000 to grandchildren in December 2008 which is within the new 5-year “look-back” period. Under DEFRA, however, the transfer ineligibility period begins, not from the date of the gift, but from the date of application for MediCal. As a result, Ozzie will not be eligible for another 11.7 months. Therefore, Harriet must use the IRA funds or part of her CSRA of $104,000 to pay for Ozzie’s private care until the end of the ineligibility period. That amounts to approximately $60,000 to $75,000. She attempts to obtain the funds from Ozzie’s IRA, in which Vanguard is the custodian. Since his DPA does not provide her with this authority, Vanguard declines her request for funds. She then has to access the remainder of the Fidelity account to pay his nursing home care for the next 11.7 months. Once this period of time is satisfied Ozzie qualifies for MediCal with his name on the title of an exempt home and a non-countable IRA. Because of his ownership of these items, on his death the state of California can track them into the estate of Harriet and file a claim for reimbursement on Harriet’s death. Meanwhile, Ozzie is receiving MediCal and Harriet is now 75 years in age and remains in good health. She is receiving approximately $3,000 in income—$650 of her social security and $2,400 from Ozzie’s pension which will terminate on his death. The Fidelity account is down to $34,000 and her 401k is now at $60,000. Based on her health she could live another 12 to 15 years with less than $200,000 in assets which includes being the designated beneficiary of Ozzie’s IRA, a taxable distribution investment. Although she loves her home she feels that she must sell it for liquidity purposes. Harriet learns, however, that a sale of the home must be reported to the MediCal authorities. Since Ozzie is still on title, one-half of the proceeds are considered his own which will disqualify him from MediCal. The longer he lives, the greater the financial stress on Harriet. This is a typical predicament. Harriet consults with an attorney to petition the Court under a §3100 Petition to transfer title to the home to Harriet. The legal proceeding is costly with a fee from $4,000 to $7,000. The state is given notice of the proceeding and the state contests the petition because Ozzie is on MediCal and the home is a target for reimbursement. The judge denies the petition to transfer the home to Harriet and she is back to where she was less the attorney and Court costs. Planning for DEFRA Rather than ignore the advice to update their estate plan, Ozzie and Harriet retain the Law Offices of Jack E. Stephens for that purpose. The Trust is revised with protections and exemptions for DEFRA; they sign Transmutation Agreements; and they execute new Durable Powers of Attorney. Subsequently, Ozzie has a seizure requiring nursing home care and his dementia increases. Based on the revised Trust provisions, we transfer all assets to Harriet out of the Trust. Further, based on the Transmutation Agreement, they are now her separate property, including the home. A new Trust is arranged for Harriet as her sole and separate property as the Family Trust is abandoned. Ozzie is now impoverished with only $2,000 in his name. Harriet makes her two sons and five grandchildren the beneficiaries of her new Trust. All gifting to family members has ceased including the proposed gift for 2008. Harriet now has control of all assets including Ozzie’s IRA because of the new Durable Powers of Attorney. Prior to applying for MediCal we designate the $40,000 cash values in the life insurance as a part of the $104,000 CSRA. The remaining $64,000 of CSRA exemption is allotted to the Fidelity account which is now the separate property of Harriet. Based on the value of the Fidelity account, $525,000, we have an excess of $465,000 over and above the CSRA limit. It is decided to place Ozzie in a MediCal qualified nursing home and begin to pay privately. We designate $65,000, or approximately payments of one year for that purpose. Next, we meet with a “qualified” financial planner and invest $400,000 in a MediCal qualified annuity for the benefit of Harriet. She will receive an income stream from this annuity for approximately 5 years which will amount to about $7,259 per month. This income stream will be considered an after acquired asset (from MediCal eligibility of Ozzie) and exempt as to his eligibility. In essence, it does not affect his MediCal eligibility and MediCal continues. Harriet may then reinvest this money however she wishes. Further, since the home is her sole and separate property, she may sell it if she wishes or remain in it and leave it to her two sons without a threat of a MediCal reimbursement claim. Single Person After Ozzie’s death, Harriet has concerns about her home should she also require nursing home care. As part of her Sole and Separate Property Trust, we included provisions for her sons David and Ricky to act for her to protect the home. It includes a provision to arrange a MIDGIT (MediCal Intentionally Defective Grantor Irrevocable Trust) to protect the home from a MediCal reimbursement claim should she receive MediCal benefits. Harriet is in hopes her limited long term care insurance of 2 years and her remaining funds of $300,000 will allow her to pay privately. She realizes that she will have no ability to transfer assets in order to qualify for MediCal because of the new Transfer rules under DEFRA. Also a concern is the fact that her home has increased in value to $900,000. The limits for qualifying for MediCal is $750,000 in home equity. As her legal advisor, we recommend that Harriet arrange a loan against her home to reduce it to the $750,000 limit. The $200,000 in loan proceeds are placed in an especially designed annuity which is non-countable for MediCal eligibility. We prepare the MIDGIT in which we transfer the home and retain a right of occupancy for Harriet. Should she go into a nursing facility, spenddown her remaining assets and apply for MediCal, her home will be protected from a MediCal claim because the Trust, not Harriet, owns the home. On Harriet’s subsequent death, the home transfers to her sons without reassessment from property tax and they receive a full step-up in basis which avoids capital gains tax once it is sold. By planning for DEFRA properly in revising the documents, Ozzie and Harriet provided financial security for the non-ill spouse without the necessity of selling the home; petitioning a Court; or the worry of a MediCal reimbursement claim and the impoverishment of the non-ill spouse. Life became better for Harriet which is exactly what Ozzie intended. Happy New Year, Jack E. Stephens   04/30/2008  FINANCIAL ALERT Beware of unscrupulous annuity salesmen who pose as “Living Trust Consultants” who use the Trust as a hook to sell you annuities or other financial products. Once DEFRA is in place, I anticipate a plethora of notices regarding annuities to shelter assets and that scams will abound in this area once this law is implemented. I was personally on a mailing list for “Security Financial” of Orange County. I completed their post card and mailed it back. Shortly, I was contacted by a friendly voice wishing to visit me to explain a Living Trust. He was not an attorney but a salesman of sorts. I visited the one-page website which only stated that the company advised on Living Trusts although no attorney was listed on the web-site. If any of you are contacted by mail, email, fax or otherwise regarding sales of Trusts, annuities, etc. please forward them to my office so that we can screen them and report any to the proper authorities for practicing law without a license or unlawful solicitation.   04/30/2008  MEDICAL ALERT If you are advised to have an MRI or MRA by your doctor, you must determine if gadolinium will be utilized. Gadolinium is injected into the bloodstream to enhance the images. If you have kidney problems, gadolinium can cause nephrogenic systemic fibrosis (NSF). NSF is a debilitating, potentially fatal disease for which there is no cure. It causes a thickening of the skin, connective tissues, muscles and internal organs throughout the body. Gadolinium - based contrast agents (GBCAs) are produced by four (4) pharmaceutical companies in the U.S. 1. Bracco - GBCA Products: Multihance and ProHance 2. GE Healthcare - GBCA Product: Omniscan 3. Bayer Healthcare - GBCA Product: Magnenist 4. Mallinckrodt Inc. - GBCA Product: OptiMark My former employer in litigation, Howard L. Nations, Esq. of Houston, Texas is a leading litigator on these issues and other pharmaceuticals. For more detailed information, go to his website, www.howardnations.com and click on pharmaceuticals.   04/30/2008  IRA ALERT If you have an IRA with Vanguard be aware that it is changing their beneficiary designation policy in September 2008. It could cause unintentional beneficiaries receiving IRA funds on your death if you have different beneficiaries listed on various IRAs.   11/06/08  SEMINARS Please call the office at (858) 792-0909 for seminar dates and times.   01/01/09  ALERT We Must update all Transmutation Agreements for updated assets and portfolios. If you have signed a Transmutation Agreement, send us a schedule of your current assets. If you have not updated your Trust for DEFRA and have catastrophic illness concerns, we must do so. Give a copy of this Newsletter to friends and neighbors to help spread the word about this New Catastrophic Health Law in California called the Deficit Reduction Act. E-mail: jes@jackstephens.com 12526 High Bluff Dr.,   Suite 200   San Diego, CA 92130 Telephone: (858) 792-0909    FAX: 858-792-0806