A New Tool To Address Special Needs

In Washington’s current hyper-partisan climate, a law with strong bipartisan support is worthy of notice. Yet one such law, which had the further distinction of creating a new financial planning option for individuals with disabilities and their families, may have flown under your radar as 2014 wound to a close.

Before Congress finished the year, it passed the Achieving a Better Life Experience (ABLE) Act, which President Obama promptly signed. Among other provisions, the act created the brand-new 529A account, sometimes also called a 529 ABLE plan or simply an ABLE account. Like the 529 college savings accounts with which many Americans are already familiar, 529A accounts will provide tax-advantaged benefits. Instead of helping families save for educational expenses, however, 529As will help families support loved ones who have special needs.

Since the law only passed in December, it is too early to say with precision how these accounts will look or how valuable they will be. To some extent, we will have to wait until the accounts are available to the public. Most likely, however, the new accounts will prove useful in at least some situations, even if they are not a perfect fit for everyone.

To qualify for a 529A account, a beneficiary must meet the Social Security definition of disability, which excludes short-term or partial disability. Further, a beneficiary must have developed or been diagnosed with the disability prior to age 26. In practice, the Internal Revenue Service will verify eligibility in one of two ways. First, an individual who qualifies for Supplemental Security Income (SSI) before the age threshold will automatically be eligible. If an individual does not receive SSI benefits, he or she may still qualify if a doctor submits a letter to the Treasury secretary certifying that the individual is blind or has a “physical or mental impairment which results in severe functional limitations.” The letter must also confirm that the condition has lasted, or is expected to last, at least 12 months continuously.

While beneficiary eligibility will be confirmed at the federal level, 529A programs will be state-run. As such, the programs may not roll out rapidly everywhere. Some states, including Pennsylvania, Maryland and California, are already looking into setting up 529A programs; other states may take longer to get started. As with 529 college savings plans, states will be able to impose their own additional rules and conditions when they set up such programs. States may choose to provide tax benefits for contributions, such as tax deductions, but are not required to do so.

Assets in 529As will grow tax-free, and distributions will not be taxed as long as they are used to pay for qualifying expenses. The definition of qualifying expenses for a 529A account is broad. Not only will it cover health and wellness expenses, but also housing, transportation, education, employment training and legal fees. If withdrawals are made to pay for nonqualified expenses, however, they will be taxed at ordinary income rates, plus a 10 percent penalty. The beneficiary, or a person able to make legal and investment decisions on his or her behalf, will make investment choices within the plan’s options, and can alter these elections twice every year. (This is a change from the previous once-a-year limit on existing 529s, and it applies to both 529 college savings accounts and 529A accounts.)

Perhaps most important, assets held in a 529A plan do not disqualify the beneficiary from federal and state aid, such as SSI benefits or Medicaid, as long as the total account balance does not exceed $100,000. This is a significant change, since previously, individuals with more than $2,000 in available assets were disqualified from SSI. In addition, if the 529A account balance exceeds the $100,000 limit, SSI benefits are suspended, but not terminated; if the balance falls below the threshold, SSI benefits resume. Because of this limit, 529A balances will be effectively capped at $100,000 for many beneficiaries.

While a 529A is similar to a 529 college savings account in many ways, there are some important differences in addition to the implied $100,000 funding limit. The 529As will have a yearly contribution limit that matches the federal gift tax exclusion. For 2015, that limit is $14,000 – per beneficiary, not per donor. While friends or relatives can make one-time or recurring contributions to a 529A, the account holder must be the beneficiary, and each beneficiary may hold only one account.

Further, that account must be established with the program offered in the beneficiary’s state of residence. This is a major difference; a 529 college savings account holder often shops around for a plan that offers an appealing mix of tax benefits, investment options and cost-effective administration. A 529A beneficiary will be stuck with his or her state’s plan, even if it does not compare well with those offered in other states. For states that do not offer 529As, an eligible participant may be able to seek out another state’s plan, but only if both states have set up the arrangement in advance. If the beneficiary moves, he or she will need to roll over the account into the new state’s plan.

Importantly, because the account holder must be the beneficiary, family members such as parents or grandparents will lose the option of withdrawing contributions to meet personal needs. Gifts to a 529A will be irrevocable. The accounts will not be eligible for the five-year accelerated gifting provision that applies to 529 college savings accounts, either.

Umer Malik

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