What to do with a 529 plan for a disabled child
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Are you contributing to a 529 for your child or grandchild but facing the reality that they may not attend college due to a disability? A relatively simple alternative would be to change the beneficiary of the 529 to another family member and save for your disabled child/grandchild in other ways.
But what if changing the beneficiary is not a feasible option? How can you access those funds tax-efficient and penalty-free ways without impacting the child’s federal benefits?
First, A Refresher on SSI
Supplemental Security Income (SSI) benefits are available to those who have never worked or earned enough credits to qualify for Social Security Disability Income (SSDI). For disabled children under 18, the parent’s income and assets will be considered when determining eligibility. Once the child is 18 and becomes an adult, the parent’s financial resources will no longer be considered.
The income limit for individuals to qualify for SSI is around $1,971 per month, and the asset limit is $2,000. Both marginally increase if the parent is applying for the child.
If the disabled child qualifies or is trying to qualify for SSI, you will need to consider how 529 Plans and ABLE 529 Plans can impact those benefits.
Traditional 529 Plan
Qualified distributions from 529 Plans are limited to education expenditures such as tuition and fees, room and board, and books and supplies. Up to $10,000 per year can be used on private K-12 tuition. Non-qualified distributions are subject to a 10% penalty and income tax on the earnings portion of the distribution.
You can avoid the 10% penalty if a beneficiary is deemed disabled. However, the beneficiary must meet the IRS’ definition of disabled, which is relatively strict:
He/she cannot engage in any substantial gainful activity because of a physical or mental condition, AND a doctor determines that the condition has lasted or can be expected to last continuously for at least a year or can lead to death.
If it’s an Indiana 529 Plan, you would not be subject to credit recapture for a withdrawal due to a beneficiary’s disability.
For SSI, a non-qualified distribution of 529 funds to a disabled child results in income tax on the earnings, which is taxed at the beneficiary’s rate. A parent-owned 529 Plan is considered an asset if the child is less than 18 years old.
Given the $2,000 asset limitations, parent-owned plans often complicate qualifying for benefits. A grandparent-owned 529 Plan, however, is not considered an asset, regardless of the child’s age.
ABLE 529 Plan
The “Achieving a Better Life Experience (ABLE) Act” was signed into law in 2014 to help those with disabilities save for a better quality of life without disrupting means-tested benefits. It’s similar to a Traditional 529 Plan in that the investments grow tax-free when used for qualified distributions.
Qualified distributions from ABLE 529 Plans are broadly defined. The funds should be used to maintain or improve the beneficiary’s life, well-being, and independence. Expenses can range from housing and transportation costs to assistive technology and personal support services.
For example, ABLE 529 Plan funds can be used to purchase noise-canceling headphones (assistive technology) to manage sensory overload. Like a Traditional 529 Plan, a non-qualified withdrawal leads to a 10% penalty and income tax on the earnings portion of the distribution.
To be eligible to open an ABLE 529 Plan, the following requirements must be met:
The disability was present before the age of 26 (this will change to age 46 in the year 2026), and one of the following is true:
- You are eligible for SSI or SSDI because of a disability,
- You experience blindness as determined by the Social Security Act, OR
- You have a similarly severe disability with a written diagnosis from a licensed physician that can be produced if requested.
An ABLE 529 Plan is considered an asset of the beneficiary, regardless of whether a parent or grandparent is listed as an authorized owner. The ABLE 529 Plan balance must be less than $100,000 to qualify for SSI. Like a 529 Plan, income tax is due on the earnings portion of a non-qualified distribution at the beneficiary’s tax rate.
Perhaps the most critical feature to be aware of regarding an ABLE 529 Plan relates to Medicaid. If medical assistance is paid to the beneficiary after establishing an ABLE 529 Plan, Medicaid has rights to any remaining account balance at the beneficiary’s death. To combat this concern, focus on keeping the plan at a manageable balance and drawing down the account accordingly.
Traditional 529 Plan to ABLE 529 Plan Rollover
As a part of the Tax Cuts and Jobs Act (TCJA) in 2017, tax-free rollovers from 529 Plans to ABLE 529 Plans were established. The amount you can roll over each year is limited to the annual contribution amount, tied to the annual gift tax exclusion ($18,000 in 2024). Any portion of the rollover above the annual contribution limit is taxable. If you’re looking to roll an Indiana 529 Plan to an Indiana ABLE 529 Plan, you would not be subject to recapture of the state 529 credit.
With TCJA expiring on 12/31/2025, tax-free rollovers are also set to expire. There is, however, a bill called the ENABLE Act that would make tax-free rollovers permanent. The ENABLE Act becoming law seems promising, as it passed the United States Senate in September 2024.
Conclusion
If you’re deciding between leaving a 529 Plan alone or rolling those funds into an ABLE 529 Plan, ask yourself the following questions:
- Does the beneficiary meet the IRS’s definition of disabled?
- How old is the beneficiary?
- Is protecting the beneficiary’s means-tested benefits a goal?
- Will the Traditional 529 Plan account balance be considered for SSI eligibility?
- What is the 529 Plan balance?
- How much growth has the 529 Plan realized?
Your Financial Advisor is here to help answer these questions and navigate what to do with a 529 Plan for your disabled loved one.
Olivia Maynes, CFP, is a Financial Planning Coordinator with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email Olivia at omaynes@bedelfinancial.com.