For People With Disabilities, ABLE Accounts a Step Toward Independence

An ABLE account is a tax-favored way to save for the needs of a person living with a disability. It is built on same the legal framework as 529 college savings plans, and it works in a similar way. Contributions are made with aftertax dollars to a plan with a preset menu of investment choices. Earnings compound on a tax-free basis, and withdrawals to pay for qualified expenses are tax-free, too.

The bill was first signed into law by President Barack Obama in December 2014; since then, six states have rolled out ABLE account plans. Five of these state plans offer enrollment to out-of-state residents, which means even if your state doesn't offer its own ABLE account, you can still set up an account. (It could pay to check into whether your home state has a program or has one in development, particularly if there is a state tax benefit for contributing.)

While the ABLE Act represents an important step forward for people with disabilities, like most account types, there are pros and cons, and it won't make sense in every situation. We'll take a closer look at how the plan works as well as whom it may benefit the most.

The ABLE Act Is Progress "Achieving a Better Life Experience" is more than a clever name that lends itself to a memorable acronym. The ABLE Act could actually solve a big problem that many people with disabilities and their families face: necessarily limited financial independence.

In order to be eligible for Supplemental Security Income (which pays monthly cash benefits to children and adults with disabilities) and Medicaid, a person with a disability cannot have resources exceeding a very low threshold: assets over $2,000 (for a single person) to $3,000 (for a couple) will disqualify him. That excludes the home in which the individual lives, but it includes income he earns from working, money in a checking or savings account, or any investments in his name (including the cash value of a life insurance policy). While living with limited means could be feasible for a dependent child, it presents a larger problem for an adult who lives independently either by choice or by necessity--he is forced to have limited assets in his own name or else he risks being disqualified from receiving federal aid.

An ABLE account, however, allows an individual with a disability to have up to $100,000 in his own name and still qualify for means-tested federal programs (with limited exceptions). This means a person with a disability can get a job, save money, and live more independently.

"The ABLE account helps people with disabilities live up to their fullest potential and be better integrated into community," explains Deborah Goodkin, managing director of Enable Savings Plan, First National Bank of Omaha. "(An ABLE account) helps someone have financial independence. With ABLE they can have a bank account; they can spend money."

How It Works The same federal law that established 529 plans provides the framework for ABLE accounts. The two account types are alike in many ways.

• States can use their own guidelines to set up the plans. For instance, different states' plans are run by different plan administrators and offer different menus of investment options, have different fees and lifetime maximum contributions (often in line with the maximum contribution of the state's 529 plans, which range from $260,000 to $500,000), and may offer a tax break on contributions (there is no federal tax break available for contributions).
• Contributions are made with aftertax dollars to a plan with a preset menu of investment choices. Earnings compound on a tax-free basis, and withdrawals to pay for qualified expenses are tax-free.
• Like a 529 account, there is no income limit to set up an account, and the contribution amount is $14,000 per year from all sources.

There are some important differences between ABLE and 529 accounts, however.

• Eligibility is limited to individuals with significant disabilities, the onset of which occurred before the individual turned 26 years old.
• ABLE accounts have a Medicaid payback provision, meaning that upon the death of the account beneficiary (who is the account owner), the state in which the beneficiary lived may file a claim to all or a portion of the funds in the account equal to the amount in which the state spent on the beneficiary through its state Medicaid program.
• Qualified expenses for ABLE accounts are broader than traditional 529 college savings plans. They include education, housing, transportation, employment training and support, healthcare, legal fees, funeral and burial expenses, and more. (However, like a 529 college savings plan, there would be a 10% penalty tax imposed on any funds not used for qualified purposes, plus any income tax on the earnings.)
• Only one account per beneficiary is allowed.

For more information, read "ABLE Accounts: 10 Things You Should Know" from the ABLE Account National Resource Center.

Who Would Benefit From an ABLE Account? Goodkin says there are three main types of individuals who typically set up an ABLE account: a person with a disability who is older than 20; a conservator or guardian on behalf of an adult with a disability; and parents of a minor with a disability.

There are some important factors to weigh when deciding whether an ABLE account makes sense, particularly when deciding between an ABLE account and a special needs trust. A special needs trust is usually set up by a third party (such as the parents or family members of a person with a disability) for the benefit of the individual. The virtue of the trust--versus having the person own the assets outright--is that it preserves the beneficiary's eligibility for federal aid such as SSI and Medicaid. Some important considerations come down to the total amount saved, whether there are legacy concerns, and sensitivity to the initial and ongoing costs of setting up the account.

An ABLE account might make more sense if:

• There is sensitivity to the expense of setting up an account: You must pay an attorney to properly draft a special needs trust, whereas an ABLE account is simple and inexpensive to set up. In addition, an ABLE account is much more tax efficient than special needs trusts because distributions from an ABLE account is tax-free when used for qualifying expenses, and the earnings will compound tax-deferred. Special needs trusts, by contrast, are subject to yearly income taxation.

However, a special needs trust may make more sense in the following circumstances:

• If there is a large account balance and a plan to pass the remaining assets to other heirs. (Special needs trusts, when set up as a third-party trust, do not have a Medicaid payback clause.)
• If there is a plan to invest a very large sum: ABLE accounts have yearly contribution limits ($14,000) and a maximum lifetime funding amount (determined at the state level).

Financial planner Michael Kitces explored this topic in depth in this blog post. (Note: the article was written before legislation was passed making ABLE accounts in certain states available to out-of-state participants.) In Kitces' article, he also discusses the feasibility of using the two account types side by side: saving up to $100,000 in an ABLE account and spending that down first, and putting any money exceeding $100,000 in a special needs trust. In doing so, one could take advantage of the tax-advantaged features of an ABLE account with at least a portion of the funds, while setting aside additional assets that would escape Medicaid payback in a special needs trust.

Though an ABLE account may not make sense in every situation, it is an important step forward in terms of improving the financial independence of people with disabilities. In recent decades, the Americans with Disabilities Act and the Individuals with Disabilities Education Act have helped improve the lifestyles of people with mental or physical disabilities through better integration of the education system, improved hiring practices for applicants with disabilities, and advanced building accessibility. The ABLE Act can be considered a step along the same path to progress.