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Should 529 Funds Be Transferred to an ABLE Account?

Special Needs

Some of my clients in the Lancaster PA area funded 529 accounts for a disabled child but the child doesn’t end up needing them for education. What are the options then?

With recent changes in tax law, account owners can now make limited transfers from existing 529 accounts to ABLE accounts with no tax consequences. Families with disabled children may be thinking about rolling existing 529 funds into ABLE accounts.

Let’s suppose you began a 529 account to build savings for college. If your child has a disability, you might consider using that money to fund an ABLE account instead, now that direct rollovers are permissible. However, before you do, let’s understand how these accounts work and how they differ.

Both types of accounts are designed to save money for children in tax-advantaged ways. Account growth is tax-deferred, and withdrawals, if spent on qualifying expenses, are also tax-free. 529 accounts are for education and related expenses. ABLE accounts pay for ‘approved’ expenses, such as housing, employment training, transportation, and supportive technology, for people with disabilities. In certain states, contributions to such accounts are deductible from state taxes, although all investment earnings remain 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. To have an ABLE account, the beneficiary must have developed a disability by age 26. Annual contributions to ABLE accounts are limited to $15,000, much lower than 529s (which can be as high as $200,000, depending on state of residency).

529 accounts provide better protection than ABLE accounts with respect to government benefits. 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 for their disability, they don’t have to report these assets.

ABLE account rules, on the other hand, can compromise a beneficiary’s access to government benefits. The disabled individual loses his/her eligibility for SSI and Medicaid if the account value exceeds $100,000. Also, upon the beneficiary’s death, Medicaid can claim any funds left in his ABLE account as reimbursement for Medicaid money spent during his lifetime. Medicaid has no such claim on money left in 529 accounts.

What 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. The contributor may also owe state taxes on past contributions, if such transactions are tax-deductible in your state.

In many cases, 529s have an advantage over ABLE accounts. If you use 529 money not on educational expenses but toward the care and support of the beneficiary, and you can demonstrate that the beneficiary has a disability that prevents her from being gainfully employed, the IRS will waive the 10 percent penalty. This option is not available in ABLE accounts.

Having an ABLE account can be a good way to set money aside for your disabled child. However, if you have established a 529 plan, consider keeping it in place rather than transferring the funds to an ABLE account. Remember, the best advice is customized for your personal situation. Call our office to get the best advice for your situation.