Living with a disability can be pricey, as data shows households with a disabled adult require an average of 28% more income.
ABLE accounts for the future expenses of a person with special needs can create tax breaks, but some wealthy families still use the more established, though more complicated, special needs trusts (SNTs). Which is better and under what circumstances?
ABLE accounts were created in 2014 by the passage of the Stephen Beck Jr. Achieving a Better Life Experience Act of 2014, or ABLE Act. “One of the key benefits is that Social Security won’t count up to a total of $100,000 of the ABLE account, decreased by the amount of the owner’s other outside assets, as a countable resource toward Supplemental Security Income (SSI) asset limits,” said Jennifer Junker, chief fiduciary officer at Arden Trust Company in Atlanta.
“Some states offer state income tax deductions or credits for contributions,” said Mark Raymond Jr., disability advocate and national outreach lead for ABLE Today, which works to increase awareness of the accounts. He added that ABLEs have tax-free growth and tax-free withdrawals for qualified disability expenses. Contributions to ABLE accounts are made with after-tax dollars and are not deductible on federal income tax returns.
“Qualified disability expenses [include] education, housing, healthcare and transportation,” said Ken Van Leeuwen, managing director and founder of Van Leeuwen & Company in Princeton, N.J. Other qualified expenses include assistive technology and legal and administrative fees.
Recent changes to ABLEs impact tax considerations. In 2019, the ABLE to Work Act allowed ABLE account owners who are employed and not covered by a retirement plan to contribute an additional amount up to the federal poverty level for a one-person household, Raymond said. “Additionally, the ABLE Financial Planning Act of 2019 allows for a one-time rollover of funds from a 529 college savings plan into an ABLE,” he added.
Contributions to ABLEs are capped at the annual gift tax exclusion: $17,000 for 2023.
SNTs may provide wealthier families the opportunity to accumulate assets over and above the ABLE account limits without impacting eligibility for federal benefits, “and with more flexibility with the use of the funds,” Van Leeuwen said.
Noting that some states cap how much can be in ABLE, Junker said that some families use both vehicles. “The ABLE provides flexibility to access funds as needed for qualified expenses,” she said, “while the special needs trust, frequently funded at well over $100,000,” can pay for expenses that fall outside “qualified.”
Only a small percentage of those eligible for an ABLE have one, according to the ABLE National Resource Center.
SNTs, the more-established planning tool for special needs, can also take assets, such as windfalls from a settlement, out of consideration for the SSI cutoff threshold for assets of just $2,000. An SNT can hold the assets in trust solely for the beneficiary; income earned on the assets in the trust is not taxed until distributed to the beneficiary.
SNTs are either first- or third-party trusts. The former are generally treated as grantor trusts for federal income tax purposes, with all income earned by the trust taxable directly to the beneficiary, Junker said.
Third-party trusts are created to benefit family or friends for the benefit of a person with a disability and are generally taxed as complex trusts, which may carry out taxable income to the beneficiary or subject income to tax, Junker said.
“A first-party trust is funded with the beneficiary’s own assets, such as a personal injury settlement or an inheritance,” Van Leeuwen said. “In this case, earnings in the trust would be subject to income tax at the beneficiary’s income tax rate, and the beneficiary of the trust would be responsible for paying the tax on the income and any distributions from the trust.”
A third-party trust is taxed as a pass-through entity. “The trust must show income earned each year, including rents, dividends, interest and any realized gains,” Van Leeuwen said. “The trust is then able to deduct any distributions made to the beneficiary ... Undistributed income would be subject to taxes at the trust’s tax rates, which he said could be “onerous.”