The Achieving a Better Life Experience (ABLE) Act of 2014 allows states to set up ABLE account programs, which function similarly to state-run Section 529 college savings programs. 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. The following describes how you can take advantage of this tax-advantaged opportunity.
You can set up an ABLE account under a qualified ABLE program established and maintained by a state or state agency. Earnings from ABLE account investments can accumulate tax-free federal income, and tax-free withdrawals can be taken to pay qualified expenses for the account beneficiary. This provides a tax-smart way to save for and pay expenses for loved ones with disabilities.
The IRS has ground rules for ABLE account programs, including the following:
- Only cash contributions are allowed.
- The annual contribution limit matches the annual federal gift tax exclusion. For 2021, the gift tax exclusion is $15,000. It increases periodically for inflation, but only in $1,000 increments. In turn, the general contribution limit for ABLE accounts for 2021 remains at $15,000.
- For 2018 through 2025, a designated ABLE account beneficiary can contribute an additional amount based on his or her compensation or self-employment income.
- The individuals can change the investment direction of an ABLE account as often as twice in each calendar year.
- 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.
A designated ABLE account beneficiary must be an eligible individual for the tax year. An individual may be eligible if they fit one of the following categories:
- People who are 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
- People who have filed disability certifications with the IRS or signed physician’s diagnoses, 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.
The before-age-26 requirement eliminates the possibility of setting up ABLE accounts for individuals who become blind or disabled later in life.
Tax Treatment of Contributions
Taxpayers cannot deduct contributions to an ABLE account for federal income tax purposes. However, state income tax benefits may apply.
Individuals must make contributions in cash, and any person can contribute for the benefit of the designated account beneficiary. No income limits exists for the account beneficiary or the contributor. Even 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 2021, the exclusion amount is $15,000. However, in 2018 through 2025, additional amounts can potentially be contributed, thanks to a Tax Cuts and Jobs Act (TCJA) provision. Under that provision, the annual limit on ABLE account contributions is increased for 2018 through 2025. Once the general contribution limit has been reached ($15,000 for 2021), the designated ABLE account beneficiary can himself or herself contribute an additional amount up to the lesser of the applicable federal poverty line for a one-person household for the prior year, or the designated beneficiary’s compensation for the contribution year.
For the account beneficiary to be eligible for the additional contribution privilege for the year, no contributions can have been made on behalf of the account beneficiary to a defined contribution qualified retirement plan, such as a 401(k) or profit-sharing plan.
Thanks to another TCJA provision, contributors can potentially claim an additional bonus. Contributions made by the designated ABLE account beneficiary to his or her account in 2018 through 2025 may qualify for a federal income tax credit known as the retirement savings contributions credit or, more simply, the “saver’s credit.”
In general, an ABLE account beneficiary is potentially eligible for the saver’s credit if he or she meets the following requirements: age 18 or older, not claimed as a dependent on another person’s individual income tax return, and not a student.
The credit can cover up to 50% of the ABLE account contribution, subject to a credit maximum of $1,000.
Ben, a blind individual designated as the beneficiary of an ABLE account, lives in Georgia. In 2021, he works to earn $20,000 in wages for the year, and no retirement plan contributions are made on Ben’s behalf for the year.
In 2021, Ben’s parents contribute the general maximum of $15,000 to his ABLE account. Ben himself can make an additional 2021 contribution of up to $12,490, which stands as the lessor of his $20,000 of compensation for 2021 or the $12,760 federal poverty line for a one-person household for 2020.
Ben must make any additional contribution for his 2021 tax year by December 31, 2021.
In addition, Ben can potentially claim a saver’s credit of up to $1,000 for 2021, based on his 2021 contributions to his ABLE account.
Tax Treatment of Distributions
Distributions from ABLE accounts are federal-income-tax-free to the extent that they don’t exceed the designated beneficiary’s qualified disability expenses for the year. Qualified disability expenses are any expenses related to the designated account beneficiary’s blindness or disability, including:
- 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
- Other expenses specified by IRS regulations
As you can see, these include basic living expenses and are not limited to expenses for which a medical necessity exists or expenses that solely benefit the designated account beneficiary.
Tax Treatment of Nonqualified Distributions
The account beneficiary’s gross income includes distributions in excess of the designated account beneficiary’s qualified disability expenses. These excess distributions also receive a 10% penalty tax. The ratio of nonqualified distributions for the year to total distributions for the year determines the amount included in gross income.
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.
There are several other key rules that you should understand when deciding whether to set up an ABLE account for a loved one.
Investment options: 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. You can change an ABLE account’s investment direction as often as twice in each calendar year.
Rollovers: 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.
Beneficiary changes: 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.
Tax Results When Account Beneficiary Passes Away
Upon the death of an ABLE account’s designated beneficiary, the remaining account balance is first paid out to cover any outstanding qualified disability expenses of the designated beneficiary.
Next, any remaining balance — net of any premiums paid from the account to a Medicaid Buy-In program — is paid to reimburse the state Medicaid plan for medical assistance paid for the designated ABLE account beneficiary after the account was established. But that payout happens 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 that is not subject to any payback provision.
Any remaining balance is distributed to the estate of the deceased designated ABLE account beneficiary or other beneficiary named to receive account funds after the death of the designated 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.
Reap the Benefits
Compared to 529 accounts, taxpayers have underappreciated and underutilized ABLE accounts. An ABLE account can serve as a helpful financial planning tool to assist a family member or loved one with a disability. Get started today by contacting a Hantzmon Wiebel team member to discuss the pros and cons of setting up an ABLE account.
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