In previous newsletters, we have discussed both so-called “529 accounts”, which are a type of tax-efficient education savings accounts and ABLE accounts, which are a relatively new type of account that can be established to provide additional resources for persons receiving Supplemental Security Income (SSI) benefits. While each account is for a different purpose, they do share some similar features.
Due to a recent law change, it is now possible to make limited transfers from existing 529 accounts to ABLE accounts without tax consequences. Accordingly, families with special needs children might want to consider rolling over existing 529 funds into ABLE accounts.
After the birth of a child, some parents establish a 529 account for the child to save for their college education. If the child has special needs, they may to consider using that money to fund an ABLE account instead, especially now that the tax code makes direct rollovers possible. Before doing so, it is important to understand how these two accounts are similar and how they are different.
Both accounts are designed to set money aside for children in tax-advantaged ways. Earnings grow tax-deferred, and withdrawals, if spent on qualifying expenses, are also tax free. Funds from 529 accounts are intended for education and related expenses. ABLE accounts are intended to pay for approved expenses, such as housing, employment training, transportation, and supportive technology, for people with disabilities. The investment earnings are not untaxed as long as funds taken from the account are used for “qualified disability expenses.”
ABLE accounts are more restrictive than 529s in several ways. A beneficiary of an ABLE account must have developed a disability by age 26 to qualify. Annual contributions to ABLE accounts are limited to $15,000, much lower than 529s (which can be as high as $529,000 in California). So if you are considering transferring 529 funds into an ABLE account, keep that $15,000 limit in mind—especially if other family members want to contribute to the ABLE account that same year.
College savings accounts provide better protection than ABLE accounts with regard to government benefits. For example, parents can open 529 accounts under their own names, so that their children are beneficiaries, not owners. If the children ever apply for government benefits, they don’t have to report any assets that aren’t held in their names.
The rules around ABLE accounts, on the other hand, can compromise a beneficiary’s access to government benefits. The special needs individual loses his eligibility for Supplemental Security Income (SSI) and, by extension, Medi-Cal if the account value exceeds $100,000.
What happens if money is used from these accounts on expenses that don’t qualify? For either 529 or ABLE accounts, one can expect to pay penalties if the money comes out of the account’s growth and earnings, there is a10 percent penalty as well as income tax on the withdrawn amount, in addition to any applicable state taxes.
In such cases, 529s have an advantage over ABLE accounts. If 529 money is not used on educational expenses but toward the care and support of the beneficiary, and it can be demonstrated that the beneficiary has a disability that prevents him or her from being gainfully employed, the IRS will waive the 10 percent penalty (though still liable for the income tax portion). This option is not available in ABLE accounts.
Having an ABLE account can be a sensible way to set money aside for your special needs child. Depending on your circumstances, if you have already established a 529 account, you might want to keep it in place rather than transferring the funds to a new ABLE account.