Most of us are aware of the opportunity to rollover or transfer retirement accounts such as IRAs without income tax consequence. Some are familiar with 1031 exchanges allowing a sale of one property and the purchase of another deferring the taxation to sometime in the future.
Insurance companies have a similar tax deferral method called a 1035 exchange where one annuity can be moved to another annuity be it the same or a different company. With a 1035, a non-compliant annuity can be exchanged for a MCA (needed to qualify for Medicaid) with no income tax being owed at that time provided a certain requirement is met: the owner and annuitant on the new contract are the same as on the old contract.
To outright surrender the annuity or sell it would cause the owner to incur taxation for no reason. Tax on the deferral would come due which, if the client has had the annuity for many years, can be substantial. It makes more sense for the agent or financial planner to 1035 it to the correct product.
This is only a strategy to save tax dollars and doesn’t address annuities that may still be in a surrender period. In a surrender period the client may be assessed a surrender charge if the annuity is sold, surrendered, or moved to another company. In this case an assessment should be made to determine if using a MCA for the purpose of Medicaid qualification saves the client more money than the cost of the surrender charge. The variable is, not knowing how long the disabled client may live. Assuming a reasonable life expectancy the high cost of care is usually greater than the surrender charge expense.
If you need a MCA don’t surrender it and pay taxes. Instead 1035 exchange it for the correct annuity. Make sure the MCA is written by a financially strong insurance company with at least a AM Best A rating. The company must put on the contract a Non-Assignment Endorsement. The annuity has to be:
No Cash Value
To help protect your savings use the tax code to pay as little in taxes as legally possible. This will help you stay in control of your own money.