Generally, variable annuities have two phases:

• The "accumulation" phase when investor contributions - premiums - are allocated among investment portfolios - subaccounts - and earnings accumulate; and
• The "distribution" phase when you withdraw money, typically as a lump sum or through various annuity payment options.

If the payments are delayed to the future, you have a deferred annuity. If the payments start immediately, you have an immediate annuity.
(See also SEC: Variable Annuities: What You Should Know; and see annuitytruth.org)

So, how does Medicaid view these investment tools? Money is never "money" when dealing with Medicaid. It is either a resource or is income. Under the Medicaid rules, a deferred annuity is a "resource" and an actuarially sound immediate annuity is (or should be) "income." Resources and income are subject to different rules. In general (very simplistic) terms, resources must be spent down until the Medicaid applicant has no more than $2,000 in countable resources (or a higher threshhold where there is a healthy spouse living in the community). With certain exceptions, virtually all income is paid toward nursing home care and, when the money runs out, Medicaid pays the balance of the nursing home bill.

Section 3258.9 of Center for Medicare and Medicaid Services's (CMS's) State Operations Manual provides:

Annuities.--Section 1917(d)(6) of the Act provides that the term "trust" includes an annuity to the extent and in such manner as the Secretary specifies. This subsection describes how annuities are treated under the trust/transfer provisions.

When an individual purchases an annuity, he or she generally pays to the entity issuing the annuity (e.g., a bank or insurance company) a lump sum of money, in return for which he or she is promised regular payments of income in certain amounts. These payments may continue for a fixed period of time (for example, 10 years) or for as long as the individual (or another designated beneficiary) lives, thus creating an ongoing income stream. The annuity may or may not include a remainder clause under which, if the annuitant dies, the contracting entity converts whatever is remaining in the annuity into a lump sum and pays it to a designated beneficiary.

Annuities, although usually purchased in order to provide a source of income for retirement, are occasionally used to shelter assets so that individuals purchasing them can become eligible for Medicaid. In order to avoid penalizing annuities validly purchased as part of a retirement plan but to capture those annuities which abusively shelter assets, a determination must be made with regard to the ultimate purpose of the annuity (i.e., whether the purchase of the annuity constitutes a transfer of assets for less than fair market value). If the expected return on the annuity is commensurate with a reasonable estimate of the life expectancy of the beneficiary, the annuity can be deemed actuarially sound.

To make this determination, use the following life expectancy tables, compiled from information published by the Office of the Actuary of the Social Security Administration. The average number of years of expected life remaining for the individual must coincide with the life of the annuity. If the individual is not reasonably expected to live longer than the guarantee period of the annuity, the individual will not receive fair market value for the annuity based on the projected return. In this case, the annuity is not actuarially sound and a transfer of assets for less than fair market value has taken place, subjecting the individual to a penalty. The penalty is assessed based on a transfer of assets for less than fair market value that is considered to have occurred at the time the annuity was purchased.

For example, if a male at age 65 purchases a $10,000 annuity to be paid over the course of 10 years, his life expectancy according to the table is 14.96 years. Thus, the annuity is actuarially sound. However, if a male at age 80 purchases the same annuity for $10,000 to be paid over the course of 10 years, his life expectancy is only 6.98 years. Thus, a payout of the annuity for approximately 3 years is considered a transfer of assets for less than fair market value and that amount is subject to penalty.

When all of this language from CMS is boiled down into plain English, if you use an annuity to tie up money beyond your life expectancy, then you will be penalized (ineligible to receive Medicaid).

To make matters more confusing, the Georgia Medicaid annuity rules changed, effective May 1, 2005. The new rules (ABD Manual Section 2339) provide:

Annuities are considered trust property. An annuity that is actuarially sound is treated as a retirement fund. An annuity that is not actuarially sound is subject to the appropriate trust provisions. Beginning May 1, 2005, any annuity that is not amortized is treated as a transfer of resources, even annuities that were previously excluded.

An annuity is a financial entity that provides to the purchaser the right to receive periodic payments, either for life or for a specified period of time.

An annuity is usually purchased as part of a retirement plan. Treatment of annuities is determined by whether or not the individual purchased the annuity as part of a legitimate retirement plan, or as an attempt to shelter resources for purposes of receiving Medicaid.

Using the Social Security Administration's Life Expectancy Actuarial Tables for the age and sex of the purchaser in this section, determine if the expected return from the annuity is equal to the purchase price.

• If the expected return is equal to or greater than the purchase price, the annuity is actuarially sound. Treat as a retirement fund. Refer to Section 2332, Retirement Funds to determine how to treat retirement funds.
• If the expected return is less than the purchase price, the annuity is not actuarially sound. The difference between the expected return and the purchase price is a trust. Treat under the appropriate trust provision. Refer to Sections 2336, Trust Property - Medicaid Qualifying; Section 2337, Trust Property OBRA '93; and Section 2338, Trust Property, to determine the correct treatment of trusts.

So, what does all of this mean? In sum, it means that annuities will be closely scruitinized if you need Medicaid to help you pay for nursing home care and they may cause you to lose eligibility if they are not carefully structured. Sometimes they help you and sometimes they cause more harm than good. You should consider the investment value, tax consequences and potential Medicaid consequences of annuities before making an annuity purchase.