Protecting Your IRAs And Other Qualified Money

Huge numbers of married people have worked hard and saved money through the years in IRA’s, 401Ks, or 403B’s to use in their retirement. IRS and tax consultants call these “Qualified” assets because they qualify under the tax laws to defer income taxes until funds are taken out of the “Qualified” account. But if one spouse’s health declines to the point where long term care is needed, either at home or in an institution, prior planning can make all the difference in the world between losing most of that nest egg to long term care, or preserving it for the healthy spouse to live on.

Since it is rare to know years in advance if one spouse or the other will need long term care, and since most everyone would prefer to get that care at home if possible, it is important to know the tax law, and the Medicaid regulations, and how to use those to protect the assets so that the couple can afford to live in their home while getting care paid for by Medicaid. The first thing to know is that assets of the sick spouse can be transferred to the healthy spouse’s name at the last minute. Then under the Medicaid rules, those assets can be protected. A problem arises if the sick spouse cannot sign. That is why a comprehensive Power of Attorney is an absolute
necessity. It cannot be just any standardized form, but must include specific authority to give away assets to the other spouse, including qualified money such as IRA or 401K’s or 403B’s.

If that language is clear in the power of attorney, then the first steps can be done, and the IRA or other qualified money can be transferred. But here is where a tax problem comes, because when you transfer your IRA or other tax deferred money to your spouse, it is going to trigger an income tax on the entire amount transferred. Let’s say the sick spouse has saved hard and the IRA is worth $200,000 or $300,000 or more. That transferred amount will be added to the social security and pensions of both spouses and depending on their tax bracket, could result in $50,000 or $100,000 or more of income taxes. That is a huge tax bite and a significant part of
the couple’s life savings may be saved under Medicaid rules, but will be lost to income taxes.

The solution is to include in the power of attorney specific language that allows the
healthy, competent spouse to get a court order that transfers the IRA or other qualified money into the name of the healthy spouse, without incurring any income tax. That is called a Qualified Domestic Relations Order (QDRO) and only a court can issue such an order. The power of attorney must have specific language that can be taken to a court and have a QDRO issued. The court order will then satisfy the Medicaid and income tax laws so that the entire IRA or 401K or 403B will be transferred to the healthy spouse without paying income taxes on it. Of course there will be income tax due when the healthy spouse withdraws the money over the years, but it will most likely be in a lower tax bracket and taxes will be minimized. The healthy spouse will still have to take other steps to qualify the sick spouse for Medicaid if they exceed the limit for Medicaid, but those steps can be taken without losing a significant amount to taxes. 

Protecting qualified money by being able to get a QDRO can be the difference between having your spouse at home or having to go to a nursing home. A word to the wise here is sufficient. Make sure you have the legal tools you need in case you become unable to sign for yourself.