People often seek immediate annuities because they want a steady income. However, financial advisors talk up another benefit as well: Such annuities may allow clients to qualify for Medicaid-a poverty program-even if they are well-heeled.

While that might seem an odd need, consider that an immediate annuity complying with Medicaid rules can save your clients money on nursing home costs, which can reach $75,000 or more annually. It could also help them save on the average $3,100 per month they would pay for an assisted-living facility. Beyond Medicaid, an immediate annuity can furthermore help veterans meet asset thresholds for Veterans Aid and Attendance pension benefits that help pay for assisted-living facilities.

Medicaid will not pick up a nursing home tab until a client's assets have been spent down to some amount, typically $2,000 to $3,000, depending on the state you live in. Veterans Aid and Attendance pension benefits may not kick in until a client's assets have declined to less than $30,000 or so. That's where the immediate annuity can help-it may allow clients to convert assets to an income stream that falls beneath the state and federal threshold requirements.

States have long challenged this practice, but a newer federal law has set some ground rules for Medicaid applicants, making state challenges more difficult.

Dale M. Krause, a De Pere, Wis., elder law attorney and insurance agent, has made these types of annuities his specialty. His company, Krause Financial Services Inc., has seen its Medicaid and veterans annuity business double since 2005. He attributes that growth to the advent of so many assisted-living facilities and to the unfavorable stock market, which wiped out assets seniors had earmarked for long-term care. With assets down, seniors have had to turn to other solutions to fund that care.

Also helping Krause's business, however, is the Deficit Reduction Act of 2005, which took effect in February 2006. This law severely limited seniors' long-standing practice of giving away assets at less-than-fair market value to relatives or others in order to meet the Medicaid eligibility thresholds. Under the new law, Medicaid can look back even farther in the client's history, going back five years instead of only three, to find out if assets were gifted at less than market value. If they were, it can delay a person's eligibility for Medicaid.

But Krause says that while the 2005 act became more stringent about Medicaid rules in one regard, it also helped pave the way for immediate annuities as a tool to shelter countable assets for those trying to qualify for the program. If Medicaid annuities were unacceptable as a way to qualify for Medicaid, as states often had claimed, the Deficit Reduction Act would have prohibited them. But it didn't.

Under the newer laws, to be Medicaid compliant, an annuity must name the state as primary remainder beneficiary. The state may be a secondary beneficiary if there's a spouse, minor child or disabled child. Medicaid applicants also must disclose any interest in an annuity. The annuity must be irrevocable and non-assignable. And it must be actuarially sound, based on Social Security tables, and pay out in equal installments during its term with no deferrals or balloon payments. Generally, this won't include tax-deferred annuities.
"If the purchase of an annuity fails to meet those criteria, the purchase will be treated as disposal of an asset for less-than-fair market value," warns Greg Womack, an Edmond, Okla., financial planner.

An immediate annuity, Womack says, may prove an especially attractive way to shield a couple's assets. Once one spouse enters a nursing home or assisted-living facility and applies for Medicaid, the rules place certain limits on the amount of assets the non-institutionalized spouse may keep. So it might be a more attractive option to convert all the couple's assets into income through the immediate annuity.

"We've done just a couple [of Medicaid compliant annuities] over the last few years," Womack says. "Most were pre-planning. We work with an elder law attorney because every state is different."

The states, which are fighting dwindling budgets and spiraling debt, are setting their own rules when it comes to Medicaid-compliant annuities. They are also cracking down on misleading sales of annuities to seniors. Whether a state will accept a Medicaid annuity now largely depends on whether there are strong litigators, hired by seniors or their families, willing to pose challenges to state laws, says Krause. In "strong bar" states such as Pennsylvania, New Jersey and Ohio, it doesn't take long to get Medicaid annuities accepted. Nor have there been problems in Massachusetts or New York.

The toughest place to get an immediate annuity qualified for Medicaid is Tennessee, Krause says. Another state, North Dakota, "will challenge just about any product that comes before them," he adds, while South Dakota has contended that the Medicaid annuity is a countable resource because it is an "uncompensated transfer." You don't get the full value in return.

Another argument by some of the states is that the annuities have value in a secondary market, say if a client were to sell it through companies like J.G. Wentworth and Peachtree. If the annuity has this value, it can be construed as an asset rather than an income stream, and it thus disqualifies an aspiring Medicaid applicant from meeting the low $2,000-$3,000 threshold.

To counter that, Krause says he has unsuccessfully tried to obtain a letter from J.G. Wentworth to refute this argument and say the annuity could in fact not be sold. But Steve Harris, sales manager of the Bryn Mawr, Pa., company's annuity purchase program, says such letters are against company policy because of the wide variety of annuity contracts, riders and situations.

To help keep it from being construed as an asset in the eyes of companies like J.G. Wentworth and Peachtree, it's important for the client to make sure the contract has non-assignment language in it.

More financial services professionals are turning to the Medicaid and veteran annuity business because traditional variable annuities are a tough sell, Krause says. The stock market is shaky and seniors, who already have variable annuities, are reluctant to exchange them while values are down and lose their death benefit guarantees. (When a policyholder dies, beneficiaries of variable annuities often are guaranteed its market value or original principal-whichever is greater.)

Annuities aimed at qualifying clients for veterans' pension benefits are less restrictive than Medicaid annuities and likely can be obtained from virtually any insurance company.

However, it's increasingly tough, Krause says, to find an insurance company that will issue a Medicaid-compliant annuity. Reason: The state rules vary so dramatically and the life spans of these policyholders are so short there's not much opportunity for profit.

But a couple of companies work with Krause. Those include Old Mutual Financial Life Insurance Company, Baltimore (recently purchased by New York private equity fund Harbinger Capital Partners) and Employees Life Co. (Mutual) of Lake Bluff, Ill.

Richard P. Leach, a senior vice president at the latter insurer, says the Deficit Reduction Act largely killed the balloon-style Medicaid annuities his company pioneered around 1986. Virtually all states-except California, which had not yet adopted the Deficit Reduction Act as of this writing-prohibit balloon-style annuities. Most Medicaid annuities today are short term, typically designed to allow persons seeking Medicaid benefits to give larger sums to heirs during the five-year Medicaid look-back period. Some Medicaid annuities, he says, have terms as short as two years or even six months!

But there is still much that can go wrong with annuities. That's why they are not always the first tool an elder law attorney reaches for in his arsenal when it comes to sheltering assets for his elderly clients' long-term care needs.

If a client going into assisted living is sold an annuity to qualify for veterans benefits, that product had better be especially flexible. That's because the client may need it to quickly become Medicaid compliant if a nursing home stay later becomes necessary, Krause says.

You don't want your client to be handcuffed, for example, by steep, long-term surrender fees.

Womack warns that a Medicaid annuity might be ineffective in a state that considers not only the value of your assets but also your income to qualify for Medicaid.

Also, an immediate annuity can't be changed by the policyholder. It may not be a client's best option to qualify for Medicaid if he or she wants to leave money for loved ones.