Medicaid planning is a process through which and individual attempts to qualify for Medicaid sooner than he would without planning and to preserve assets for his or his family’s benefit.  Much of Medicaid planning involves transferring, or gifting, assets to family members.

One of the biggest issues that I see with clients in recent years is that the client has significant assets in qualified accounts such as Individual Retirement Accounts or 401(k)s.  For instance, assume that Mrs. Smith, age 75, owns her home worth $200,000 and an IRA worth $400,000.  Mrs. Smith is interested in protecting her assets from long-term care costs.  She currently does not need long-term care services, but she worries that someday she may.

In order to protect Mrs. Smith’s assets, I have to remove those assets from her name.  I may suggest using an irrevocable trust in order to protect her assets, but inevitably, any Medicaid plan will involve transferring her assets out of her name.  The problem is that the vast majority of Mrs. Smith’s assets are in qualified accounts.  If she were to remove the money from her IRA, she will pay income tax on the money.  If Mrs. Smith removes $300,000 from her $400,000 IRA, Mrs. Smith will have $300,000 of extra income in that year.

Mrs. Smith probably will not want to pay income tax on $300,000 of additional income, so for all intents and purposes, Medicaid planning, at least for her IRA assets, is foreclosed.

What do I suggest?  To me, there is no clear cut answer.  Mrs. Smith may never need care, and if she doesn’t need care, paying the tax on the money she removed from her IRA could be a mistake.  Someday, Mrs. Smith will have to pay income tax on the money she removes from her IRA or, after her death, her children will have to pay tax on the money when they remove it from the IRA.  But no one wants to pay tax sooner than they have to, and that is exactly what would happen if Mrs. Smith removes the $300,000 from her IRA.

On the other hand, if long-term care costs are a significant concern for Mrs. Smith, then she may be willing to incur the income tax liability for removing money from her IRA.

I can only present Mrs. Smith with her options, and there is no easy answer.