In 2014, Congress created ABLE (a.k.a., 529A) accounts for qualified disability expenses. But several limitations became apparent as states started to establish their ABLE account programs. Fortunately, the ABLE account under the Tax Cuts and Jobs Act (TCJA) corrects some of these shortcomings. Here, we’ll take a look at those improvements, the differences between an ABLE account and special needs trusts, and how changes under the TCJA present a special needs planning opportunity for you and your clients.
Changes for ABLE Accounts Under the TCJA
1) Annual rollovers from a 529 account to an ABLE account. Before the TCJA, a 529 account could not be rolled over to an ABLE account. This meant a potential loss of the tax advantage for 529 accounts that families originally funded for children whose disability manifested later in their lives. By allowing annual rollovers from a 529 account to an ABLE account in amounts up to the gift tax exclusion, the TCJA permits a tax-advantaged account to be used for disability-related expenses instead of qualified education expenses. Currently, the annual gift tax exclusion is $15,000.
2) Beneficiary earnings contributions. ABLE account beneficiaries can now contribute their earnings to their own accounts. The cap on the beneficiary’s earnings contributions is the annual federal poverty level for a one-person household ($12,000 in 2018). But there’s even more good news! The beneficiary’s contributions are separate and in addition to his or her family’s annual contributions. Like the rollovers, the limit on the separate contributions is the annual gift tax exclusion.
3) Retirement Savings Contributions Tax Credit eligibility. Beneficiaries who make contributions to their own ABLE accounts—as opposed to contributions made by others (e.g., friends, family)—may be eligible for the Retirement Savings Contributions Tax Credit (a.k.a., Saver’s Credit). Of course, additional requirements must be met, and more detailed information is available on the IRS website.
To be sure, these changes are positive. But they do not clarify how to use an ABLE account and another popular planning tool—the special needs trust—for the same beneficiary. Let’s look at the similarities and differences between the ABLE account and the special needs trust to help you recognize the planning opportunities.
Special Needs Trust Vs. ABLE Account
ABLE accounts and special needs trusts have a common purpose: to supplement rather than supplant benefits and services provided by programs like Medicaid and Supplemental Security Income (SSI). Both are exceptions to the stringent asset rules that limit eligibility for public benefits. Aside from this similarity, however, there are some definite and nuanced differences.
Special needs trusts
A special needs trust is a legal document that an attorney drafts to suit the needs of the grantor. A first-party or self-settled special needs trust holds assets initially owned by the beneficiary. Circumstances in which the beneficiary owns the assets include awards in medical malpractice lawsuits and direct inheritances. First-party trusts are always irrevocable and established during the beneficiary’s lifetime. A third-party special needs trust holds assets contributed by the beneficiary’s family or friends. Third-party trusts can be revocable or irrevocable, but the most common type is created by a testamentary bequest in a parent’s or grandparent’s last will and testament.
Here are the criteria for a special needs trust:
- A first-party special needs trust must be established before the beneficiary’s 65th birthday.
- There is no age restriction for the beneficiary of a third-party trust.
- The same beneficiary can have a first-party and a third-party special needs trust or more than one third-party trust.
- Any asset, including real estate, can be transferred to a special needs trust.
- A beneficiary can remain eligible for SSI regardless of the amount in the special needs trust as long as distributions from the trust adhere to the specific rules for in-kind support and maintenance.
Generally, enrollment in an ABLE account is as easy as opening a 529 plan account. The administration fees are low, and investment managers like BlackRock and Fidelity offer a range of conservative and aggressive investment options for states’ programs. Here, it’s important to keep in mind that most states do not have an income tax deduction for contributions to an ABLE account. Plus, the five-year up-front gifting often used to fund 529 accounts is not available for ABLE accounts. Not all states have ABLE accounts, but some states do allow nonresidents to enroll in their programs. (The ABLE National Resource Center allows you to compare state ABLE programs and to learn whether nonresidents can enroll.)
Here are the criteria for ABLE accounts:
- The onset of an ABLE account beneficiary’s disability must occur before age 26.
- A beneficiary can have only one ABLE account.
- Only cash can be contributed to an ABLE account.
- An ABLE account balance in excess of $100,000 will affect the beneficiary’s eligibility for SSI.
Similarities and differences
Federal law. First-party special needs trusts and ABLE accounts share two characteristics set by federal law. First, there can be only one beneficiary of a first-party special needs trust or an ABLE account. Second, assets remaining in either a special needs trust or an ABLE account when the beneficiary dies must be repaid to the state’s Medicaid agency if the beneficiary received Medicaid during his or her lifetime. This repayment is known as the “payback.” It is not as onerous for a first-party trust since the beneficiary initially owned the assets. For an ABLE account, though, the state Medicaid agency can take assets originally owned and contributed by a family member or friend.
A third-party trust can have remainder beneficiaries, and it is not subject to the Medicaid payback.
Distributions. Distributions from ABLE accounts and special needs trusts can be used for a variety of expenses, including education, health care, employment training, and assistive technology. But the Social Security Administration has specific rules regarding how a special needs trust can be used for a beneficiary who receives SSI.
The Social Security Administration will reduce a beneficiary’s monthly SSI payment if distributions are made from a special needs trust for in-kind support and maintenance. In-kind support and maintenance includes food, mortgage, property taxes, rent, heating fuel, gas, electricity, water, sewer, and garbage removal. In contrast, ABLE accounts can be used for all of the in-kind support and maintenance expenses except food if the distribution is paid to the mortgage company, landlord, or utility company in the same month. For example, if a distribution is made in June to pay rent, it should be paid to the landlord in June.
Special Needs Planning Under the TCJA
Now that we’ve covered ABLE accounts versus special needs trusts, let’s come back to changes for special needs planning under the TCJA. Although each family has different considerations, there are common starting points.
A good place to begin is by determining whether there is an existing 529 account. If there is, use the TCJA to begin rolling assets to an ABLE account. Next, discuss how to use an ABLE account to complement a beneficiary’s special needs trust. You should also consider whether a grandparent’s or parent’s assets will be forfeited through mandatory payback provisions.
Since first-party special needs trusts hold assets owned initially by the beneficiary and have specific limitations, financial planning for other family members will not be a primary factor when establishing that type of trust. Helping clients integrate a third-party trust and an ABLE account into a family member’s special needs plan can be a meaningful and intergenerational planning opportunity. A grandparent’s testamentary third-party trust will allow a special needs grandchild to enjoy lifetime benefits and for other grandchildren to be remainder beneficiaries. Meanwhile, parents can contribute annual gifts to the ABLE account in an amount that fits their overall estate plan. Plus, their child can take pride in contributing his or her own income to the ABLE account as provided by the TCJA. As the balance of the account increases, parents can stop their contributions while their child continues to add his or her own income to the ABLE account.
A Layered Approach
As I think you can see, changes to the tax code have given families and financial planners several tools to aid in comprehensive special needs planning. With some thought and strategy, you can take a layered approach, using all of the options available to distribute family assets and to enhance the quality of life for a special needs family member.
Have you seen other special needs planning opportunities emerge under the TCJA? Do you make the ABLE account part of your planning discussions? Please share your thoughts with us below!
Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.