Late last year, Congress enacted new rules to improve the recently created 529A ABLE account, a tax-advantaged savings account for individuals with disabilities. Before we jump into the new rules, let’s briefly review the key advantages and distinctions of the account itself.
A Step Forward for Special Needs Planning
In 2014, Congress passed legislation to expand on the popular 529 plan for college savings, creating the 529A ABLE (or “Achieving a Better Life Experience”) account.
The new ABLE account was developed to provide parents the opportunity to save money in a tax-advantaged investment vehicle for children with special needs.
A typical 529 plan allows for tax-free distributions only if the beneficiary uses the funds for qualified education expenses. But if the beneficiary doesn’t have expenses from one of those qualified institutions, any earnings withdrawn from the 529 account are subject to taxes and penalties. For parents of children with special needs, this rule significantly limited the practical use of a typical 529 account.
In steps the 529A ABLE account, which, compared to the 529 plan, provides much more flexibility when it comes to withdrawals — distributions on expenses related to education, housing, health care, prevention and wellness are all tax-free. Like the 529 plan, ABLE accounts are administered by each individual state.
Some of the key benefits include:
— A potential tax deduction for in-state plan contributions
— Tax-free growth, provided the funds are distributed for qualified disability expenses
— Exemption from the $2,000 limit on personal assets to qualify for Supplemental Security Income (SSI), Medicare and other public benefits
— A lower start-up cost compared to a special needs trust
At the same time, ABLE accounts also come with some limitations:
— The maximum account balance is $100,000
— To qualify, the beneficiary must be diagnosed with the disability before he or she reaches age 26
— The state can potentially recapture the ABLE assets upon the beneficiary’s death
The ABLE account does not replace the potential need for a special needs trust and advanced estate planning; however, parents can think of it as an additional tool to help care for their children.
The PATH Act Impact
Recently, Congress and President Obama passed the “Protecting Americans from Tax Hikes” (PATH) Act of 2015, which provided an important change for those considering a 529A ABLE account:
State Residency Requirement: Originally, a beneficiary could only open a 529A ABLE account in his or her home state — unlike typical 529 plans, in which beneficiaries can choose to participate in any state’s plan. This provision was initially included to help states recapture assets upon a beneficiary’s passing. The PATH Act removes this requirement, providing parents with more choice in their 529A decision. Hopefully, this change will provide more competition among states to pass legislation and launch their own ABLE programs, and eventually drive lower costs and increase investment options.
Unfortunately, a widely reported change involving rollovers of existing 529 accounts was not included in the final PATH Act legislation. Currently, existing 529 assets cannot be rolled over into a 529A ABLE account for the same beneficiary. The IRS has stated that this distribution would not constitute a higher education expense, and thus, it won’t permit such a transfer on a tax-free basis.
Today, 35 states (plus the District of Columbia) have enacted legislation to sponsor ABLE programs.1 Stay tuned — we hope to see these programs launched and up and running by 2017.