Since the passage of the Deficit Reduction Act of 2005 ("DRA"), the Pennsylvania Department of Human Services ("Department") has attempted to limit the use of annuities in the asset protection strategy known as "half-a-loaf" gifting. Half-a-loaf gifting is a technique used to reduce a Medical Assistance ("MA") applicant's resources by gifting one-half of his or her resources to a family member, usually a son or daughter, and using the remaining one-half to purchase a DRA compliant annuity. The applicant becomes eligible for MA because he or she has no resources and the Department imposes a penalty, based on the value of the gift, for the nursing home payments. However, because the purchase of a DRA compliant annuity is exempted from a penalty, the applicant uses the payment stream from the annuity to pay for his or her nursing home care until the penalty expires.
Since 2005, the Department's position was that the annuities used in half-a-loaf gifting were not DRA compliant. One criteria for an annuity to be DRA compliant is that the annuity be "actuarially sound." Actuarially sound is not defined in the DRA but it is defined in Transmittal 64, the Center for Medicare Services' binding guidance to the States for administration of the Medicaid Program. An actuarially sound annuity must be "commensurate" with the reasonable life expectancy of the applicant as illustrated on the tables produced by the Social Security Administration ("SSA"). The Department's position was that an annuity must be equal to the applicant's life expectancy.
The Department's position, if correct, effectively prevented half-a-loaf gifting. To illustrate this point, consider the following simplified example: an 80 year old male, according to the SSA, has a life expectancy of 8.13 years (nearly 98 months); nursing facility care costs approximately $10,000.00 per month; to pay for 98 months of nursing facility care our 80 year old male would need to fund an annuity with approximately $980,000.00. Our 80 year old male could then gift any amount of money that did not create a penalty period exceeding 98 months. The difficulty involved in employing this strategy is obvious.
The plaintiffs in Zahner, et. al. v. The Secretary of the Pennsylvania Department of Human Resources challenged the Department's position. Zahner's position was that the annuity cannot exceed the applicant's life expectancy. In other words, all the parties agree that annuities have a ceiling, but Zahner argued annuities do not have a floor. For example, one of the plaintiffs in Zahner had purchased an annuity whose payment term equated to approximately 10% of her life expectancy.
Zahner's position, if correct, would permit half-a-loaf gifting. Consider this example of a half-a-loaf gift for our 80 year old male: an 80 year old male gifts $54,000.00 to his son or daughter and the Department imposes a six month penalty, approximately, for the gift. The penalty would begin when he spent his resources to the correct program limit, either $2,400.00 or $8,000.00. The 80 year old male then purchases an annuity for six months, which generates a great enough payment stream to pay for his care in a nursing facility and reduces his resources to the appropriate program limit. His nursing care would be paid for six months by the annuity, he has transferred wealth to his son or daughter, and he is eligible for nursing home payments as soon as the penalty expires.
On September 2, 2015, the United States Court of Appeals for the Third Circuit resolved the issue with its precedential opinion in Zahner. The Court's opinion was a thorough rebuke of the Department's position. The Court rejected the Department's position that the annuities at issue in Zahner were not DRA compliant because their term of payment was too short. The Court further found that the Pennsylvania's statute regulating annuities, 62 P.S. § 441.6(b), was unconstitutional. The Court held that the DRA created a safe harbor for complaint annuities and an annuity shall be considered compliant as long as its payment term is equal to or less than an applicant's life expectancy.
Absent action from the United States Congress or the United States Supreme Court addressing this issue, the Zahner decision will remain the law of Pennsylvania, Delaware, the Virgin Islands, and New Jersey (the jurisdiction of the Third Circuit) for the foreseeable future. Zahner's impact on elder law planning will be profound. Half-a-loaf gifting is now enshrined in the law. Persons requiring nursing facility care will now be able to transfer a large portion of their assets to their children. Some wealth will now remain within a family and not flow to an elderly parent's nursing facility.
If you or a family member needs nursing facility care, you should seek the counsel of an elder law practitioner. A half-a-loaf gift can expedite access to MA benefits while preserving wealth within a family. Short-term annuities also provide options to allow persons to qualify for MA who previously made gifts which were penalized. Obviously, no one technique is the correct course of action for everyone. But these are powerful, new tools that will greatly benefit those persons who employ them.
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