As states begin to roll out the new tax-advantaged 529 ABLE account plans, clients who have children with special needs may need help with an important decision: is it best to open a 529 ABLE account or start a Qualified Disability Trust? Both have advantages and disadvantages. Both can be used for living expenses while receiving Social Security income and Medicaid benefits.
In December 2014, a law was passed allowing states to create 529 ABLE account plans for individuals who become disabled before age 26. At the start of 2017, eleven states are offering the ability to set up a 529 ABLE account. Up to $100,000 can be saved in the account before Social Security income and Medicaid benefits are affected. This is a game-changer for many families.
Account balances can be relatively high in 529 ABLE accounts. Michigan and Virginia currently allow these accounts to have as much as $500,000 in them. However, if they surpass $100,000, the ability to collect Social Security income and Medicaid benefits is compromised.
Money in these accounts is paid with after-tax dollars; investment growth is tax-free. The money in the account can be used for qualified expenses such as medical, housing, legal fees, financial planning fees, tuition, and more. (Note: don’t get an educational 529 account and a 529 ABLE account confused; while a 529 ABLE plan can be used for tuition, it is different than a 529 college savings account.) Some states allow for a deduction for state taxes. Anyone can participate in depositing funds, including the disabled individual.
How can my client’s child qualify? If the disabled individual is collecting Social Security income, he or she is qualified. If he or she is not collecting Social Security income, the rules vary a bit by state. Typically, a letter from a doctor is necessary to verify the individual has a qualifying disability and that the onset of the disability occurred before the age of 26.
There is one big drawback to the 529 ABLE plan: any money left in an account after the disabled person passes away will be used to reimburse Medicaid. Also, the investments are pre-set in these accounts so you must use the asset allocations the state chooses (all states use low-cost index fund mixes). There is an annual deposit limit of $14,000 from all sources. Not all states allow out-of-state participants, but most do.
So, what about a Special Needs Trust? A Special Needs Trust can be set up with the help of an attorney. When set up properly, the trust can allow for savings that will not affect a disabled person's eligibility for Social Security income or Medicaid benefits. A Special Needs Trust allows more freedom for investments. The big advantage is the ability to have a higher balance.
Another big advantage: assets left in the trust do not go back to Medicaid. They will pass on to descendants upon the death of the disabled individual. There is no requirement regarding the age of onset like there is for the 529 ABLE accounts, however, the trust must be set up before the disabled individual turns 65. The individual who is disabled must be the sole beneficiary of the trust. It must be an irrevocable trust and the individual must have a qualifying disability defined by the Social Security Act.
Considering attorney fees and court fees, expense is a drawback. Special Needs Trusts can come with complex legal issues. Also, the disabled individual cannot contribute to the account.
So, which should they pick? That depends on the situation. Let’s look at a few examples.
Julie’s well-meaning grandparents leave her $15,000 when they pass away. This “wealth” would disqualify Julie from Social Security income and Medicaid benefits. What can Julie do? Because the money is in her name and Julie cannot directly contribute to her own Special Needs Trust, she should look towards a 529 ABLE account. Julie can deposit $14,000 into a 529 ABLE account. The extra $1,000 will not disrupt her benefits as it is under the maximum allowed.
Julie’s aunt Jillian gives Julie $90,000. Julie is now ineligible for Social Security income and Medicaid benefits. She can’t put the money directly into a trust. She should put $14,000 in her 529 ABLE account, using the remainder to replace her benefits from Social Security and Medicaid. The following January, she can deposit another $14,000 into her 529 ABLE account.
Julie’s other set of grandparents decide to do some pre-planning. They intend to leave a substantial amount in the ballpark of $400,000. It is important to them to ensure any leftover money stays in the family after Julie passes. A Special Needs Trust makes sense considering only $14k can be deposited in a 529 ABLE account AND they want the money to go to decedents.
Julie’s uncle Jim decides to give Julie $3,500. Due to the legal costs, it would be best for Jim to open a 529 ABLE account.
Julie’s godmother in Nebraska would like to set up a 529 ABLE account for Julie in her home state. Because Julie already has one in another state, she can’t do this. Individuals can only be the beneficiary of one 529 ABLE account.
Guiding your clients to the right decision for them means fully understanding their needs and grasping the parameters of both options. For more on this topic, please visit:
About the Author: Vernon Welch is the owner of Strong Oak Financial LLC, a fee-only firm that works with teachers and families with special needs. To learn more about Vernon and Strong Oak Financial, you can connect with him here.