529 or ABLE Account?
Written by: Connor Kavanaugh, Special Needs Planner
October, 16th 2020
You did it by the book. As soon as your little one entered this world, you made the responsible decision of opening a 529 College Savings Plan for your loved one. Good work! If your child experiences a disability, you may be thinking about using that money to fund an ABLE account instead, especially now that the tax code makes direct rollovers possible.
Yes, you read that correctly! Thanks to the changes from the Tax Cuts and Jobs Act 2017 legislation, families can now make limited transfers from existing 529 accounts to ABLE accounts with no tax consequences. Families with special needs children may be thinking about rolling existing 529 funds into ABLE accounts.
But before you do, make sure you understand how these two accounts work and how they differ. Both types of 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 (named for the enabling federal legislation, the Achieving a Better Life Experience Act) pay for approved expenses, such as housing, employment training, transportation, and supportive technology, for people with disabilities. Note that in some states, contributions to such accounts are deductible from state taxes (though not from federal taxes), although all investment earnings remain untaxed if funds taken from the account are used for "qualified disability expenses."
As many of you know, ABLE accounts are different than 529s in several important 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 $200,000, depending on what state you live in). 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.
The rules around ABLE accounts, when not used properly, can compromise a beneficiary’s access to government benefits. The individual with a disability loses his or her eligibility for Supplemental Security Income (SSI) if the account value exceeds $100,000. Also, upon the beneficiary’s death, the state Medicaid agency can potentially claim any funds left in their ABLE account as reimbursement for Medicaid money spent from the time the ABLE account was initially opened. State agencies have no such claim on money left in 529 accounts. (NOTE: Oregon along with four other states repealed their state Medicaid payback in 2017)
What happens if you use money from these accounts on expenses that don’t qualify? For either 529 or ABLE accounts, expect to pay penalties if the money comes out of the account’s growth and earnings. You will be charged 10 percent as well as income tax on the withdrawn amount, in addition to any applicable state taxes. And the contributor may now owe state taxes on past contributions if such transactions are tax-deductible in your state.
Having an ABLE account can be a great way to set money aside for your special needs child. If you have already established a 529 College Savings Plan and are considering making the transfer to an ABLE Account instead, make sure you talk to your special needs planning team to find a strategy that works best for you and your family!