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 These under-appreciated accounts similar to 529 plans can be useful tax-smart savings tools


 ​Morning Star
Oct 22, 2020
By Bill Bischoff
Provided by Dow Jones

A financial-planning vehicle for a loved one with a disability

The Achieving a Better Life Experience Act of 2014 (ABLE Act) allows states to set up ABLE account programs. In turn, you can establish a tax-favored ABLE account to cover qualified disability expenses of a family member or loved one named as the designated account beneficiary. Here's what you need to know about how ABLE accounts work and the tax advantages they offer.

An ABLE account must be set up under a qualified ABLE program that's established and maintained by a state or state agency. As explained later, earnings from ABLE account investments can accumulate federal-income-tax-free, tax-free withdrawals can be taken to pay qualified expenses for the disabled account beneficiary. So, this is a tax-smart way to save for and pay expenses for a loved one with disabilities.

1. Only cash contributions are allowed.

2. The annual contribution limit equals the annual federal gift tax exclusion. For 2020, the gift tax exclusion is $15,000. It is periodically increased for inflation, but only in $1,000 increments. So, the exclusion for 2021 will almost certainly remain at $15,000. In turn, the general contribution limit for ABLE accounts for 2021 will almost certainly remain at $15,000.

3. For 2018-2025, the designated ABLE account beneficiary can contribute an additional amount based on compensation or self-employment income. More on that later.

4. There's a 6% penalty tax on excess contributions, so you don't want to go over the annual limit.

5. You can change the investment direction of an ABLE account up to twice each calendar year.

6. You can establish and contribute to an ABLE account under any state's ABLE program, regardless of where you live or where the designated account beneficiary lives.

Observation: If these rules remind you of the guidelines for Section 529 college savings accounts, you are not mistaken.

The designated beneficiary must be an eligible individual.

* An individual is an eligible individual for the tax year if during that year he or she is entitled to benefits based on blindness or disability under the Social Security disability insurance program or the Supplemental Security Income (SSI) program, and that blindness or disability occurred before age 26 or

* The individual has filed a disability certification with the IRS or has a signed physician's diagnosis stating that: (1) the individual has a medically determinable physical or mental impairment that causes marked and severe functional limitations and that can be expected to result in death, or that has lasted or can be expected to last for a continuous period of at least 12 months, or is blind and (2) the disability or blindness occurred before the individual reached age 26.

Key point: The before-age-26 rule eliminates the possibility of setting up ABLE accounts for individuals who become blind or disabled later in life.

Contributions to an ABLE account are not deductible for federal income tax purposes. However, state income tax benefits may be available.

Contributions must be made in cash, and any person can make a contribution for the benefit of the designated account beneficiary. There are no income limits for the account beneficiary or the contributor. Billionaires can contribute.

Total contributions to a designated beneficiary's ABLE account in a year are generally limited to the annual federal gift tax exclusion for that year. For 2020, the exclusion amount is $15,000, so that is the general limit on contributions to an ABLE account in 2020. However, in 2018-2025, additional amounts can potentially be contributed, thanks to a Tax Cuts and Jobs Act (TCJA) provision explained below.

Under the Tax Cuts and Jobs Act (TCJA), the annual limit on ABLE account contributions is increased for 2018-2025. Once the general contribution limit has been reached ($15,000 for 2020), the designated ABLE account beneficiary can himself or herself contribute an additional amount up to the lesser of: (1) the applicable federal poverty line for a one-person household for the prior year or (2) the designated beneficiary's compensation for the contribution year. For the 48 contiguous states and the District of Columbia, the 2019 poverty line for a one-person household was $12,490.

Yolanda, age 30, is an individual with a disability who is the designated beneficiary of an ABLE account. She lives in Colorado. In 2020, she is employed and earns $20,000 in wages for the year. No retirement plan contributions are made on her behalf.

In 2020, Yolanda's parents contribute the general maximum of $15,000 to her ABLE account. Yolanda herself can make an additional 2020 contribution of up $12,490: the lesser of: (1) her $20,000 of compensation for 2020 or (2) the $12,490 federal poverty line for a one-person household for 2019.

Thanks to another TCJA provision, contributions made by the designated ABLE account beneficiary to his or her account in 2018-2025 are potentially eligible for the federal income tax Retirement Savings Contributions Credit. This is the so-called Saver's Credit, and it can be up to 50% of the ABLE account contribution, subject to a credit maximum of $1,000. In general, an ABLE account beneficiary is potentially eligible for the Saver's Credit if he or she is age 18 or older, is not claimed as a dependent on another person's Form 1040, and is not a student.

Same facts as in the preceding example. Yolanda can potentially claim a Saver's Credit of up to $1,000 for 2020, based on her 2020 contributions to her ABLE account.

Distributions from ABLE accounts are federal-income-tax-free to the extent they do not exceed the designated beneficiary's qualified disability expenses for the year.

These are any expenses related to the designated account beneficiary's blindness or disability. They include: education; housing; transportation; employment training and support; assistive technology and personal support services; health, prevention, and wellness services; financial management and administrative services; legal fees; expenses for oversight and monitoring; funeral and burial expenses; and other expenses that are specified by IRS regulations. As you can see, qualified disability expenses include basic living expenses and are not limited to expenses for which there is a medical necessity or expenses that solely benefit the designated account beneficiary.

Distributions in excess of the designated account beneficiary's qualified disability expenses are included in the account beneficiary's gross income and are also hit with a 10% penalty tax. The amount included in gross income is based on the ratio of nonqualified distributions for the year to total distributions for the year.

In effect, when distributions for the year exceed qualified disability expenses, the distributions are treated as consisting of: (1) a pro-rata tax-free return of principal amount from account contributions and (2) a pro-rata taxable amount from accumulated account earnings.

State-run ABLE programs generally offer investment options similar to those offered by state-run 529 college savings plans. For example, you may be able to select an "aggressive growth" portfolio consisting of mutual funds from well-known providers, a "moderate growth" portfolio, or a "conservative income" portfolio. As stated earlier, you can change an ABLE account's investment direction as often as twice in each calendar year.

ABLE account distributions can be rolled over federal-income-tax-free within 60 days to another ABLE account for the benefit of the designated beneficiary or an eligible individual who is a member of the designated beneficiary's family, as defined.

You can change an ABLE account's designated beneficiary federal-income-tax-free, as long as the new beneficiary is an eligible individual who is a family member of the original beneficiary.

Upon the death of the ABLE account's designated beneficiary, the remaining ABLE account balance is first paid out to cover any outstanding qualified disability expenses of the designated beneficiary.

Next, any remaining balance is paid to reimburse the state Medicaid plan for medical assistance paid for the designated ABLE account beneficiary after the account was established (net of any premiums paid from the account to a Medicaid Buy-In program), but only if the state files a claim for such reimbursement. Because of this payback provision, it may be advisable to keep only a limited amount of funds in an ABLE account. Additional funds can be kept in a special needs trust (link) that is not subject to any payback provision.

Any remaining ABLE account balance is distributed to the estate of the deceased designated ABLE account beneficiary or other beneficiary named to receive ABLE account funds after the death of the designated ABLE account beneficiary. To the extent such post-death distributions consist of ABLE account earnings, they are included in the recipient's income for federal income tax purposes, but no penalty tax is owed.

If the tax rules for ABLE account contributions and distributions remind you of the guidelines for Section 529 college savings accounts, you are not mistaken. However, unlike 529 accounts, it's probably fair to say that ABLE accounts have been underappreciated and underutilized to date. But you are now in the know. You understand why an ABLE account can be a helpful financial planning tool if you want to help out a family member or loved one with a disability.

-Bill Bischoff; 415-439-6400; AskNewswires@dowjones.com


 
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POSTED: 10/26/2020