On February 8, 2006, the Deficit Reduction Act of 2005 became law. The Act makes several changes to the Medicaid program that will significantly affect long-term care planning, and modifies federal higher education programs, most notably parent and student loan programs. Here is a look at some of the major provisions of the Act that may impact your finances.

Medicaid and long-term care planning

When you're planning for long-term care, you'll want to pay close attention to provisions in the Act that significantly tighten restrictions on Medicaid planning.

One of the biggest changes affects what's known as the Medicaid look-back period, which is the amount of time that an applicant's financial records are subject to review by state Medicaid authorities to see if assets such as money or property have been transferred to others for less than full fair market value. Prior to enactment of the Deficit Reduction Act, the look-back period was three years. Now, individuals must disclose any transfers made within five years of applying for Medicaid.

If you transfer assets that are counted as available resources for Medicaid purposes for less than fair market value during the look-back period, the state may presume that you made the transfer solely to qualify for Medicaid, and delay your eligibility for Medicaid for a certain period of time (called the "penalty period"). Formerly, this penalty period began the month (or the month after) a transfer had been made, and could end before an individual even applied for Medicaid. Under the Act, however, this penalty period will generally begin to run only after an individual has applied for Medicaid and the application has been approved. This means that someone who enters a nursing home may have to pay out of pocket for months or even years to compensate for gifts made to individuals or charities long before he or she became ill. The Act does, however, provide for a hardship waiver of the penalty period in some cases.

Another important provision of the Act caps at $500,000 the amount of home equity an individual can have and still qualify for Medicaid; states are allowed to increase this cap to a maximum of $750,000. Formerly, all home equity was considered exempt. However, the new cap does not apply to Medicaid applicants with spouses or dependent children who are residing in the home. The cap applies to Medicaid applications filed on or after January 1, 2006. The amount of the cap will be indexed for inflation after 2010.

Here's a summary of other important changes:

• Transfers to purchase life estates have been limited.
• Generally, immediate annuities must now meet certain requirements in order to qualify as noncountable assets for Medicaid, and must name the state as the remainder beneficiary (or secondary beneficiary after a spouse or minor or disabled child).
• Generally, Medicaid applicants must now disclose to the state any interest the applicant or community spouse has in an annuity; states may also now require an issuer to notify the state when income or principal is withdrawn.
• Continuing care retirement communities (CCRCs) and life care communities may now require residents to spend resources declared on their entrance fee contracts for their care before applying for Medicaid.
• States will be urged to adopt long-term care insurance partnership programs. These allow individuals who are insured by approved long-term care policies to qualify for Medicaid once long-term care insurance benefits are exhausted, without having to spend down part or all of their assets.

Medicare

Some Medicare beneficiaries will be affected by a provision in the Act that accelerates the scheduled increase in Part B premiums for higher-income individuals that was enacted as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Originally set to phase in over five years, this premium increase will now phase in over three years, beginning in 2007. Individuals with income at or above a certain threshold will be affected (for 2007, the threshold is set at $80,000 for single beneficiaries, or $160,000 for married beneficiaries).

Federal higher education programs and college savings

If you're planning for college, you should be aware of several provisions in the Act that affect financial aid. One important provision modifies the Stafford and PLUS loan programs. Borrowers' rates on new student (Stafford) and parent (PLUS) loans are scheduled to switch from a variable-rate formula to a fixed rate (6.8% for Stafford loans and 7.9% for PLUS loans) effective July 1, 2006. The Act allows the switch from variable to fixed rate loans to take effect, but raises the fixed rate for PLUS loans from 7.9% to 8.5%. In addition, graduate and professional students are now eligible to borrow under the PLUS program (effective July 1, 2006).

The Act also makes some changes to the federal financial aid formula that will benefit borrowers. Effective July 1, 2006, prepaid tuition plans will be treated as an asset of the parent (assuming the parent is the account owner) instead of as a resource, the same way 529 college savings plans and Coverdell education savings accounts are treated. This is a positive development for anyone using a prepaid plan to save for college because amounts paid out under a prepaid plan will no longer reduce financial aid dollar for dollar. In addition, effective July 1, 2007, the dependent and independent student contribution from assets will decrease from 35% to 20%, and the dependent and independent student income protection allowance will increase.

Here's a summary of other changes that may affect you:

• The maximum amount for subsidized Stafford loans made to first-year students has been increased from $2,625 to $3,500, and the maximum amount for loans made to second-year students has increased from $3,500 to $4,500 (effective for loans made on or after July 1, 2007).
• The loan limit for unsubsidized Stafford loans made to graduate or professional students has been increased from $10,000 to $12,000 (effective for loans made on or after July 1, 2007).
• Borrower's origination fees for subsidized and unsubsidized student loans have been reduced.
• Military members who are serving on active duty or performing qualifying National Guard duty may now defer repayment of some student loans for up to three years.

The Act also establishes a new grant program to supplement the Pell Grant program. Grants from this program will be available from 2006 to 2010. To be eligible, students must be U.S. citizens attending school full time who are eligible for a Pell Grant, and must meet other specific requirements. Academic Competitiveness Grants will provide up to $750 to first-year students and up to $1,300 to second-year students who meet program requirements. National Science and Mathematics Access to Retain Talent (SMART) Grants will provide up to $4,000 to third- or fourth-year students majoring in math, science, technology, engineering, or a foreign language critical to national security.

Insured retirement account deposits

There's some good news for you if you have substantial retirement funds in a certificate of deposit, savings account, or other type of insured deposit account offered by a bank or credit union. The Act raises from $100,000 to $250,000 the aggregate limit on federal deposit insurance coverage for certain retirement account deposits insured by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Association (NCUA). Accounts may include traditional and Roth IRAs, self-directed Keogh accounts, 457 plan accounts, and self-directed defined contribution plan accounts.

Caution: Only deposits, not investments, are insured. Investment accounts or products such as mutual funds, stocks, bonds, life insurance policies, and annuities used to save for retirement are not insured by the FDIC or NCUA, even if you purchased them from an FDIC- or NCUA-insured institution.