The United States Court of Appeals for the Third Circuit recently decided a case that greatly impacts Medicaid planning in New Jersey. I was fortunate enough to write one of the legal briefs that were filed with the Third Circuit. I was asked to write a brief on behalf of the National Academy of Elder Law Attorneys in support of the Medicaid applicant’s appeal.

The Third Circuit is the federal appeals court that handles appeals from federal trial courts located in New Jersey, Pennsylvania, and Delaware. The Third Circuit is an appellate court immediately below the Supreme Court of the United States, so what the Third Circuit has to say on a legal issue is very important and often is the final word on an issue.

Medicaid is a medical payment program for needy individuals. If an individual qualifies for Medicaid, Medicaid will pay for most of the costs associated with long-term care, such as care in a nursing home. Because long-term care can be so expensive, costing anywhere from $9,000 to $12,000 a month for a nursing home in New Jersey, many individuals who never thought they would have to qualify for a needs-based program such as Medicaid find themselves wanting to qualify for Medicaid if they require long-term care.

Medicaid planning is a process through which individuals, usually in conjunction with an elder law attorney, seeks to qualify for Medicaid quicker than they would qualify for Medicaid without planning, preserving a portion of their estate for themselves or their family. There are many different Medicaid planning techniques that elder law attorneys employ.

One technique involves the use of a Medicaid-complaint annuity to convert assets into a stream of income. Assume the following facts: Mr. Smith resides in a nursing home. Mrs. Smith lives at home. The Smiths own the following assets—a home, a car, and $200,000 in cash.

The Medicaid program will permit Mrs. Smith, who is known as the “community spouse” in Medicaid parlance, to retain the home, the car, and half the cash, or $100,000. The other half of the cash must be spent down on Mr. Smith’s care, or at least that is what Medicaid would want the Smiths to do with that cash.

Assets, such as the $200,000, are all counted against Mr. Smith’s eligibility for Medicaid except for the assets that the Medicaid program permits Mrs. Smith to retain, which in this example is $100,000. Income, on the other hand, belongs to the person whose name is on the check. So, for instance, even if Mrs. Smith received $20,000 a month in income from a pension, all of that income would be hers and would not affect Mr. Smith’s eligibility for Medicaid.

Because Mrs. Smith’s income does not affect Mr. Smith’s eligibility for Medicaid and because payments from a properly structured annuity are considered income, Medicaid-complaint annuities offer a planning technique. In the example above, if Mrs. Smith were to purchase an irrevocable, non-assignable annuity with the $100,000 that she otherwise would have to spend down on Mr. Smith’s care and if that annuity paid her back the purchase price of the annuity plus interest over a period of time that was actuarially sound given her age, then the annuity would effectively convert the extra $100,000 into a stream of income that did not count against Mr. Smith’s eligibility for Medicaid. Mr. Smith would qualify for Medicaid immediately.

The question the Third Circuit recently answered is, What is the definition of actuarially sound? More specifically, Can the term of an annuity be too short and, therefore, not actuarially sound?

Everyone accepts the fact that be to be actuarially sound, the payment term of the annuity cannot exceed Mrs. Smith’s actuarial life expectancy. So, if Mrs. Smith, age 80, had a life expectancy of 7 years, then the annuity must pay her back in no more than 7 years.

But what if the annuity paid her back in 1 year? Would it be actuarially sound then despite the short duration of the payment term? The Third Circuit said yes. While there is a ceiling to how long the annuity payment term can be, there is no floor. So, a 1 year annuity for someone with a 7 year life expectancy is actuarially sound.