Should you Transfer 529 Plan Funds to an ABLE Account?
Thanks to recent changes in the tax law, 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.
Perhaps on the birth of your child, you started a 529 account to save up for college. If your child has special needs, you may be thinking about using that money to fund an ABLE account instead, especially now that the tax code makes direct rollovers possible. 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 as long as funds taken from the account are used for "qualified disability expenses."
ABLE accounts are more restrictive 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.
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, Medicaid if the account value exceeds $100,000. Also, upon the beneficiary’s death, the state Medicaid agency can claim any funds left in his ABLE account as reimbursement for Medicaid money spent during his lifetime. State agencies have no such claim on money left in 529 accounts.
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.
In such 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 she has a disability that prevents her from being gainfully employed, the IRS will waive the 10 percent penalty (though you will still be 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. If you have already established a 529, however, you might want to keep it in place rather than transferring the funds to a new ABLE account. Speak to your special needs planner to get the best advice for your particular situation.