Medicaid Pitfalls: Cash Value Life Insurance

Qualifying for Medicaid can be a pain in the neck: You can only qualify for benefits if you have a limited amount of assets and income. Yes, there are some exceptions, but in most cases there are financial limits. Unfortunately, people’s past investment decisions may severely impact their current eligibility.   One of the worst former financial decisions for Medicaid planning is the limits placed on cash value life insurance.


“Permanent” life insurance is meant to last until you reach age 95 or 100, then pay out to you or your beneficiary even if you are still alive. These policies allow you to invest extra money to the policy’s “cash value” so that as the annual cost of the insurance premiums increase over time, the long-term investment gains in the cash value have had a chance to grow. This effectively “front loads” the policy to defray the future increased costs of insurance, which would otherwise be prohibitively expensive (since the older you get the more expensive life insurance becomes). For years insurance salesmen have encouraged people to invest excess funds into their policy’s cash value, since the growth is at least partially tax free.


The problem is that Medicaid in New York only allows you to have $1,500 of cash value in life insurance policies. So while there is no limit as to the amount of death benefit the policies pay upon your passing, such a small cash value can’t cover the large expenses of policies for longer than a few months (sometimes even less than one month).


There are a few options available to deal with this problem:

One option is that every extra payment paid by the policy owner in the past has to be reversed and withdrawn from the policy, thereby effectively lapsing or decreasing the death benefit of the policy, becoming a wasted investment opportunity, and in some cases becoming taxable income as well.


Another option is transferring the ownership of the life insurance policy to an irrevocable trust or to a trusted child. However, the Trust or the child will have to make future payments on the policy, to prevent its lapse, and the transfer requires a Medicaid look-back period to run its course.


Permanent life insurance can be useful for people who do not wish to ever be placed on Medicaid. However, policy ownership should be changed as soon as possible once Medicaid planning is being considered, otherwise the policy transfer will incur the 5 year look-back for institutional care needs. Overall, be careful to not over-invest in your life insurance cash value, particularly if you haven’t already maximized your retirement plan contributions, because cash is always reliable, but cash value can be a liability.

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