What attorneys should remind clients at tax time about Medicaid-compliant SPIAs

As tax day approaches, many elder law attorneys find themselves revisiting conversations that began months earlier during Medicaid planning. One topic that often resurfaces is how income from a Medicaid-compliant annuity will be taxed once payments are underway.

While Medicaid eligibility is usually the primary focus, tax treatment remains an important part of the overall planning picture. Tax time is a natural moment to help clients reconnect the dots between the planning strategy they implemented and the income now showing up on a tax return.

Why this reminder matters at tax time

Medicaid planning strategies are designed to address eligibility and income flow, not to eliminate taxes. Clients may be surprised when annuity income appears on a 1099 or flows through an IRA distribution report. A proactive reminder can help avoid confusion, stress, or last-minute questions.

Tax season offers an opportunity to reinforce expectations and confirm that what clients are seeing is consistent with how these annuities are intended to work.

Immediate annuities and Medicaid planning

The annuities used in Medicaid planning are Single Premium Immediate Annuities, or SPIAs. Medicaid rules require income to begin immediately, which is why these annuities do not include an accumulation or deferral period. Once issued, payments start right away.

Because income begins immediately, each payment is evaluated by the IRS as it is received. That structure drives the tax treatment and is often the source of client questions.

What clients should understand about taxation

Each SPIA payment includes two components: a return of principal and interest earned on that principal.

When a Medicaid-compliant SPIA is funded with after-tax, non-qualified dollars, only the interest portion of each payment is taxable as ordinary income. The return of principal is not taxed. The IRS applies an exclusion ratio to determine how much of each payment is taxable over the expected payment period.

For many clients, it is reassuring to learn that purchasing a SPIA does not usually create a large, one-time tax bill. Instead, taxation is spread out and more predictable.

When retirement assets are involved

Questions often increase when retirement accounts are part of the plan. If a SPIA is funded with pre-tax dollars, such as assets from a traditional IRA, the tax treatment changes.

Because taxes were never paid on those funds, each payment from a tax-qualified SPIA is fully taxable as ordinary income. Even so, these annuities can still play a valuable role in Medicaid planning. In some cases, they allow retirement assets to be repositioned to support Medicaid eligibility without forcing a full liquidation in a single tax year.

Rather than creating one large taxable event, income is distributed over time. This does not eliminate taxes, but it can help manage the timing and flow of taxable income during a challenging period for families.

A coordinated message clients benefit from

At Ashber, we do not provide tax advice. Our role is to help structure Medicaid-compliant annuity solutions and explain, at a high level, how these annuities are generally treated from an income perspective.

Medicaid planning works best when it is collaborative. Elder law attorneys, tax professionals, and annuity specialists each contribute an essential piece. When those professionals are aligned, clients are better prepared to understand both Medicaid eligibility outcomes and the tax implications of the income they receive.

We support attorneys and their clients by helping ensure annuities are structured properly and aligned with Medicaid requirements, so there are fewer surprises when tax season arrives.