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How Medicaid Treats Life Insurance (Part 2)

                Last week I was talking about life insurance as it affects eligibility for Medicaid.  While term insurance has no value while the insured is alive and only provides a payment at the death of the insured, other types of life insurance – namely whole life and universal life – havea cash value.  It is that value that counts as an asset towards Medicaid’s $2000 asset limit.

                What are the Medicaid applicant’s options then if he/she owns a policy with cash value?  One is to surrender the policy for the cash surrender value and then spend down that amount in accordance with Medicaid’s spend down rules.  When the applicant dies there will be no death benefit because the policy has been surrendered.

                This is a reasonable option where the cash surrender value is the same – or close to the same  – value of the death benefit.  If, for example, the cash surrender value is $9500 and the death benefit is $10,000 not much is lost in value if the policy is surrender.  In fact, if the policy is not “paid up” but requires continued premium payments, the death benefit minus the continued premiums may turn out to be less than the surrender value.

                But, what if the cash surrender value is $9500 but the death benefit is $25,000 or $50,000?  If it is surrendered the death benefit will be lost.  How do I know how long Dad will live?  What if we surrender it and he passes away 3 months later?  It would be a shame to lose the death benefit on a policy he paid premiums on for many years.

                Another option could be for a family member to buy the policy.  If I have the financial means to buy Dad’s policy I pay him the cash surrender value which he must then spend down.  However, we will have the death benefit to keep, which could cover funeral bills and pass on a small inheritance that is something that is important to Dad.

                There are some potential costs to be aware of.  If the policy is not paid up then I will need to continue to pay the premiums to keep the policy in force.  If Dad lives 5 or 10 more years I need to factor that into whether it makes financial sense to keep the policy.  The other issue is income taxes.  While life insurance proceeds are received income tax free,  that is not necessarily the case when the owner of the policy purchased a policy on the life of someone else.   The proceeds become taxable, although how much is taxable depends on what I paid for the policy and how much in premium payments I made while I owned it.

                In most cases, even when factoring these costs into the equation, if the spread between the cash value and death benefit is large enough it will still make good financial sense to purchase the policy instead of letting it lapse.  However, consulting with an accountant and elder law attorney before making the decision is advisable because each instance has a different set of facts and variables to examine.