Tax Favored ABLE Accounts For Special Needs Children

Congress recently introduced a new type of account for young, disabled individuals. This is a summary of how these accounts work.

In December 2014, Congress introduced a new type of account for young, disabled individuals; the Achieving a Better Life Experience account, or ABLE account for short.

On June 22, 2015, the IRS released the widely anticipated proposed regulations, providing further clarity on how the accounts will work.  This tax-favored legislation will allow individuals and families to save for long-term needs without jeopardizing an individual’s eligibility for critical federal entitlement programs such as Medicaid.

Many people with special needs are living longer, healthier and productive lives, attending postsecondary education programs, getting married, obtaining gainful employment, and are more integrated into the fabric of society than ever before. ABLE accounts will allow individuals (and their families) to save private funds for the future without jeopardizing their eligibility for much-needed public benefits and supports, thereby increasing their quality of life, financial stability and independence.

The proposed regulations authorize any state to offer ABLE accounts.  Alternatively, a state may contract with another state that offers such accounts.  These accounts will be provided by states in a manner similar to the way states are responsible for operating 529 savings plans for education savings.  Unlike 529 savings plans, an individual may only have one account.

Example #1:

Robert lives in State X and meets the eligibility requirements to establish an ABLE account. State X sponsors a 529A plan and does not contract with any other states. Robert may only establish an ABLE account in State X.

Example #2:

Maria lives in State A and meets the eligibility requirements to establish an ABLE account. State A does not sponsor a 529A plan, but it has a contract with State X that allows its residents to utilize State X’s plan. Maria may only establish an ABLE account in State X.

In order to qualify for an ABLE account, an individual must have a significant physical or mental impairment that severely limits their ability to function. Furthermore, the impairment must be expected to result in the person’s death or be expected to last continuously for a period of 12 months or more. The individual must have been disabled before his or her 26th birthday.

Contributions to an individual’s ABLE account can be made by anyone, but the total contributions made by all individuals on behalf of one ABLE account owner is limited to the annual gift tax exemption amount. For 2015 and 2016, that amount is $14,000.

Distributions are tax-free if used to pay for qualified disability expenses. If distributions are not used for qualified expenses, the earnings will be taxable and subject to a 10% penalty. Fortunately, the list of expenses that can potentially qualify as qualified disability expenses is fairly liberal.

Per the proposed regulations qualified disability expenses…

“…are expenses incurred that relate to the blindness or disability of the designated beneficiary of the ABLE account and are for the benefit of that designated beneficiary in maintaining or improving his or her health, independence, or quality of life. Such expenses include, but are not limited to, expenses related to the designated beneficiary’s education, housing, transportation, employment training and support, assistive technology and related services, personal support services, health, prevention and wellness, financial management and administrative services, legal fees, expenses for oversight and monitoring, and funeral and burial expenses, as well as other expenses that may be identified from time to time in future guidance published in the Internal Revenue Bulletin. Qualified disability expenses include basic living expenses and are not limited to items for which there is a medical necessity or which solely benefit a disabled individual.”

After an account owner’s death, any portion of an ABLE account that is distributed to a beneficiary, will be taxed on the earnings, but the 10% penalty will not apply.

ABLE accounts remaining after the owner’s death will first be used to repay State-provided funds. In many cases, beneficiaries of such an account will not receive any benefits, even when a balance remained at death.

If an ABLE account owner is no longer disabled, the account will continue to be treated as an ABLE account for their benefit. However, beginning in the year that the owner is no longer disabled, contributions are no longer permitted to be made to the account. Furthermore, any distributions from the account will not be considered qualified disability expenses.

ABLE programs must allow that account owners can be changed, however, the new owner must also be a qualifying individual. Also, just like 529 savings plans for education, investments can be changed no more than two times in any calendar year.

Special Needs Trusts vs. ABLE Accounts

Special Needs Trust ABLE Accounts
Amount that can be safeguarded without impacting benefits? Edge to SNT – Unlimited amounts can be gifted to a SNT without impacting federal/state benefits SSI benefits will be stop once an ABLE account’s value exceeds $100,000
Potential uses of funds? Edge to SNT – While ABLE accounts definition of qualifying disability expenses is fairly liberal, SNT drafted with the appropriate language can allow for a broader array of expenses “Qualified Disability Expense” is any expense related to the beneficiary as a result of living with a disability.  See guidance published in the Internal Revenue Bulletin in article
Tax Efficiency? Income that is generated by a SNT and not paid out of the trust to trust beneficiaries is subject to trust tax rates Edge to ABLE accounts – Distributions from ABLE accounts, including earnings, will be tax free if used for appropriate expenses
Legacy to future beneficiaries? Edge to SNT – If SNT is established and implemented properly, the trust assets at the time of special needs person’s death, can be left to other heirs Any amount left in a person’s ABLE account at the time of their death will first repay publically provided benefits, which will probably wipe out the balance of the account
Cost and complexity? Trusts can be very expensive to create and administer and can be complex Edge to ABLE accounts – ABLE accounts will have minimal expenses and will be far simpler to implement


About the Author

Carol Schmidlin, Certified Financial Fiduciary®, MRFC® is the President of Franklin Planning and has been advising clients on how to grow and preserve their wealth for 25 years. In addition to her financial planning practice, she is the founder of FedSavvy® Educational Solutions, which provides Financial and Retirement Literacy Programs for Federal Employees. She is passionate about helping families with all phases of Wealth Management and is a member of Ed Slott’s Master Elite IRA Advisor Group. Her practice maintains a home office in Sewell, NJ along with a satellite office in Washington, DC. Carol can be reached at (856) 401-1101.