Posts Tagged ‘529 plans’

The ABLE Act — How Will You Be Able to Use It?

DECEMBER 29, 2014 VOLUME 21 NUMBER 47

Last week we told you about the passage of The Achieving a Better Life Experience Act, and tried to spell out some of the important details. But until we can all see actual cases, it might be hard to figure out how to use the new law (and the accounts that it authorizes). This week we’re going to suggest some of the ways that the new ABLE accounts might be useful — and some of the pitfalls for people who use them unwisely.

First, a caveat: we don’t really know what the ABLE accounts will look like yet. That’s because we’re collectively waiting for two things: the federal government needs to adopt regulations implementing the new law, and states need to create ABLE accounts. Neither will be complete for months, at least.

What will the ABLE landscape look like in six or nine months? We predict that there will be federal regulations, and that a number of states will have created ABLE accounts that resemble (in each instance) their existing 529 accounts. But probably not all states will have gotten on board by then. If you (or the family member you want to create an ABLE account to benefit) happens to live in a state that is lagging in implementation, the new accounts will simply be unavailable. Though you might be able to choose among the Section 529 plans of several dozen states when making a contribution, the ABLE Act limits you to the state where the person with a disability lives.

Let’s assume, though, that there is an ABLE account available. Who might set up accounts, and why would they choose an ABLE account over the other alternatives available? Let’s try some examples.

Guillermo

We’ll start with Guillermo. He is 30 years old, and he was born with Cerebral Palsy. He lives with his parents, who provide for most of his daily needs. His grandmother has just died, leaving him a small inheritance of $10,000. She did not create a special needs trust for him; she simply left him the $10,000 in his name directly.

Guillermo was disabled at birth, so he will have no trouble meeting the ABLE Act requirement that his disability had to begin before age 26. Guillermo has the mental capacity to sign a receipt for his inheritance, to open an account in his own name and to sign checks on that account — though his disability makes it impossible for him to actually sign the checks. His Supplemental Security Income (SSI) payments go into an account in joint tenancy with his mother, who makes the actual payments from the account. The bank account now has about $1500 accumulated; it is a regular problem for Guillermo and his mother to figure out ways to spend the money to keep him from losing his SSI — and the Medicaid benefits that flow from it.

Guillermo is the classic ABLE Act candidate. He could put all of his inheritance into an ABLE account, and the savings would not cause him to lose his SSI or Medicaid. He would have control over how the money was spent; he would not have to get approval from a trustee or anyone else before deciding to make a purchase. Of course, he will want to make sure his expenditures do not violate the final regulations limiting the distributions from the ABLE account, but that will probably not be any problem. In fact, Guillermo can contribute future funds to the account, too — as his SSI checking account builds up, he can put funds into his ABLE account to stay below his $2,000 limit. In this way, Guillermo can set aside savings for future expenditures — such as when he is no longer able to live with his parents.

Would Guillermo have other choices? Yes, he would. He could establish a self-settled special needs trust, or participate in a pooled special needs trust. Either of those would likely have more start-up costs than his ABLE account, and the fees charged by either a separate trustee or a pooled trustee would likely exceed the annual administrative costs in the ABLE account. Most importantly, perhaps, the ABLE account would permit Guillermo to directly control his money, which is a terrific advantage.

Guillermo’s Grandmother

Knowing what a good idea the ABLE account looks like for Guillermo, should his grandmother have just set up an ABLE account before her death? Absolutely not. Why not? Because of the ABLE account’s payback requirement.

Looking at the same transaction from Guillermo’s grandmother’s perspective, it looks completely different. It would be simplicity itself for her to modify her will to provide that the $10,000 bequest to Guillermo should be held in a third-party special needs trust — probably naming his parents as trustees, and his sister as successor trustee. The cost? Perhaps an additional few hundred dollars over the cost of her basic will. The advantages? Complete discretion in how to handle Guillermo’s money (admittedly it would be handled by his parents, but there’s nothing that prohibits them from letting Guillermo make many of the decisions for them), no administrative costs, and no payback requirement.

Guillermo’s Grandfather

Meanwhile, Guillermo’s grandfather (from the other side of the family) is planning on leaving a larger bequest to Guillermo — he is going to leave Guillermo a full 1/4 of his estate. Could he utilize the ABLE account? Absolutely not. Why not? Because his gift will be more than the $14,000/year that could be contributed to all ABLE accounts for Guillermo’s benefit, and so ABLE is simply not a choice. He could, of course, make annual contributions of $14,000 until he has put 1/4 of his total estate into the account, but that’s not what he wants to do — and besides, he is in his 80s and might not live long enough to transfer Guillermo’s full inheritance into the account.

Guillermo’s Mother

Guillermo’s family is not wealthy, but his mother thinks she could afford to put as much as $10,000 per year aside for Guillermo’s future needs. Should she utilize an ABLE account? Almost certainly not.

What’s wrong with ABLE accounts for Guillermo’s mother? The payback issue is a real problem, and one that’s easily avoidable by her setting up a third-party special needs trust. Yes, that does mean that she will need to pay the cost of creating a trust, but there will not be any continuing cost for administering the trust. She can consult with an attorney, create a trust, and start contributing funds to the trust right away. She can expressly permit expenditures that the ABLE accounts might preclude. She can invest the trust’s money in any way that seems appropriate to her — not just Guillermo’s state’s ABLE provider. She can look for lower-cost and higher-yield investments if she chooses.

Would the answer be different if Guillermo’s mother only intends to contribute $2,000 per year? Not really. She ought to start with the very small investment of talking with an experienced attorney to figure out whether she really wants to create either a trust or an ABLE account; there might be even smarter, more cost-effective options (like just creating a separate account in her own name and earmarking it for Guillermo’s benefit).

Wendy

Wendy is very much in the same situation as Guillermo, with one important difference: her disability is Down Syndrome, and her ability to make her own decisions is very limited. Her parents have been appointed as guardian (of her person); otherwise, her situation is similar to Guillermo’s. In fact, Wendy’s grandmother has just died, leaving $10,000 in her name. Is her situation the same as Guillermo’s?

Not quite. The cost of an ABLE account will actually be higher for Wendy, since she can not sign a receipt for her grandmother’s estate, or negotiate the check she receives. Her parents will probably need to go back to court to get appointed as her conservator (what is called guardian of the estate in some states) in order to set up the ABLE account. Depending on her local court, they may have to file annual accountings for the ABLE account even after it is set up.

For Wendy, a pooled special needs trust might be more suitable. Yes, there will be a small start-up cost, and there will be a payback requirement at her death. But the administrative expenses are likely to be lower than the cost of a continuing court proceeding. The best answer for Wendy might vary from state to state, from county to county, and even from year to year.

What if Wendy’s SSI bank account builds up to more than the $2,000 she’s permitted to keep? The excess might very well be directed to an ABLE account. The reason the answer is different: her mother, as representative payee, has the authority to set up the account, and the administrative costs are therefore lower than they would be for a pooled special needs trust.

Wendy’s Accident

Unfortunately, Wendy was a passenger in a van that was hit by a negligent driver. The good news: Wendy’s injuries were slight, she has recovered completely, and the negligent driver was insured. His insurance company has offered $5,000 to settle her claim.

Can this money be put in an ABLE account? Yes, and that might be the best choice. Like the small inheritance from her grandmother, there will be some administrative costs (getting the court to approve the settlement and allow the ABLE account), but the ABLE account might be the best alternative. That will especially be true if her grandmother’s inheritance was already put into an ABLE account AND the accident settlement is in the next year.

Guillermo’s Accident

Tragically, Guillermo was also injured in an auto/van accident the year after he received his inheritance from his grandmother. His injuries were more serious: the insurance company is offering $60,000 to settle his claim. Can he use his ABLE account?

If you’re paying attention, you probably think the answer is “no.” But it’s not. There is a two-step way Guillermo can use his ABLE account to receive the lawsuit settlement.

First, he could agree with the driver’s insurance company to make not a single $60,000 lump-sum payment but annual payments of $9,000 for seven years. That means that he would actually get a few more dollars in total settlement. Each year’s $9,000 can be contributed to the ABLE account without running afoul of the $14,000 annual limitation (which will rise to $15,000 within a couple years of Guillermo’s accident, making it even easier).

Of course, Guillermo still will have a payback requirement upon his death. But the language of the ABLE payback is considerably gentler than the payback requirements for special needs trusts — the ABLE account should be available to pay Guillermo’s funeral and burial expenses, for instance, without requiring that he prepay those bills.

Guillermo’s Sister

Guillermo was not alone in the van. His sister Louise was also in the van, and she was horribly injured. She was disabled by the accident; her work history is such that she receives about $500/month from Social Security Disability and another $300/month from SSI. Because she gets SSI, she also gets Medicaid coverage. She was 28 at the time of the accident.

Can Louise’s potential settlement be directed to an ABLE account, in the same way that her brother’s was? Absolutely not. Why not? Because her disability onset was after age 26. That arbitrary (and unfair) limitation, incidentally, is not based on anything but budget considerations; if Louise and people like her had access to ABLE accounts, the anticipated cost to the treasury would mushroom and Congress could not figure out how to pay for it.

Your Situation Here

As you can see, it might be hard to figure out whether an ABLE account is the right way to resolve a particular person’s problem. Some generalizations, though: if you are considering setting aside your money for a family member with a disability, ABLE is probably not your best choice. If the problem is how to handle money belonging to the person with a disability, there are quite a few factors to consider. You should get good legal advice to figure out the best solution in your situation.

ABLE Act Passes — We’ll Tell You What It Means

DECEMBER 22, 2014 VOLUME 21 NUMBER 46

The Achieving a Better Life Experience Act passed the U.S. Senate last week, and President Obama signed it over that same weekend. But what does it mean for people with disabilities, and for their families? How will you be able to use the accounts authorized by the ABLE Act?

The ABLE Act is loosely connected to Section 529 of the Internal Revenue Code. You might recognize that number — the prior law created very popular accounts for prepaid tuition. There is lots of information about 529 Plans, including the popular “Saving for College” website. To better understand ABLE, it might make sense to first describe how 529 plans work.

529 Plans

There are dozens of 529 Plans available. Almost every state has adopted at least one 529 Plan (some states have more than one). They often look very much like mutual funds; you put your money into the account, it is managed by the administrator, and it grows along with the market (or the segment of the market utilized by your particular plan).

You can invest your money in a 529 Plan set up by a state other than yours, or where your prospective student lives. So you might live in Arizona, have a grandchild in Arkansas, decide to invest in Alaska’s plan (it happens to be administered by T Rowe Price), and ultimately use the account to pay for your grandchild’s education in Alabama (just to stay in the “A” states). Not every state’s plan allows out-of-state investments, but most do. There are also “Prepaid Tuition” plans available in many states; they are just what the name implies, though usually the funds can be used for other colleges when the time comes (though there may be incentives to keep the money, and the student, at the predetermined college).

You can set up a 529 Plan for, say, your child — and both sets of grandparents can set up separate accounts for the same student. The multiple plans for a given child can be from different states. The maximum asset limit is set in each plan; if you make more than a $14,000 contribution to a plan for a given student in one year, you may have to file a federal gift tax return (there’s a special rule if you contribute up to $70,000 in one year, but that’s going too deeply into 529 Plans for our purposes).

If you do set up a 529 Plan for a child or grandchild, and that prospective student dies, decides not to go to college, or gets a really good scholarship, you can change the beneficiary of your plan to another family member. You keep pretty impressive control over the plan — and yet it is not considered part of your estate for federal estate tax purposes.

Though you do not get any income tax deduction when you do set up a plan, any later withdrawals for qualified education expenses come out of the plan tax-free. That means that no one has to pay the income tax on the interest and investment income over the years the plan is in place. That’s one of the best parts of a 529 Plan.

ABLE Accounts

The new ABLE Accounts will be similar to 529 Plans in a number of ways, but very different in others. In fact, the ABLE Act creates a new section, right after Section 529, of the tax code. It’s numbered as Section 529A, just to make the connection clearer. Here are some of the highlights of the new Section 529A:

  • A person with a disability can only have an ABLE Account if they were severely disabled by age 26. Why this limitation? It’s mostly about federal budgets; if every person with a disability could open an ABLE Account, the projected cost of the program would mushroom. What does it mean to have a disability before age 26? The easy answer is that someone who was receiving Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI, or SSD) benefits by that age qualifies. Others might qualify, but it will be harder to establish eligibility.
  • Each person with a disability can have just one ABLE Account, and it must be set up in the state where they live. If they move to another state, the account probably will not have to move. But that raises a fairness issue: if the state where the person with a disability resides just doesn’t offer an ABLE Account, he or she will not have the option available.
  • Contributions to an ABLE Account may not exceed $14,000 in a given year. That’s total contributions — if the person with a disability puts in, say, $5,000, then other family members may not contribute more than $9,000. That figure is indexed to the maximum annual gift tax exclusion amount (though gift taxes are mostly irrelevant to ABLE Accounts), so it should go up to $15,000 in a year or two.
  • The maximum size of an ABLE Account will be set by state law. Expect it to be in the range of several hundreds of thousands of dollars. But if the account grows to more than $100,000, the beneficiary will lose Supplemental Security Income (SSI) benefits — but not state Medicaid eligibility.
  • When the ABLE beneficiary dies, remaining assets in the account go to the state Medicaid program which provided benefits during life (after payment of other pending bills, and limited to the amount the Medicaid program actually paid for the beneficiary’s care).
  • If ABLE Account funds are used to pay for “qualified disability expenses,” there will be no income taxation on the interest or gain in value of the ABLE assets, and the expenditure will not be counted as income to the beneficiary. We don’t yet know exactly what “qualified disability expenses” will mean, as we’ll have to wait for the government to define the term. The law does say, though, that the categories for “qualified” expenditures will include “education, housing, transportation, employment training and support, assistive technology and personal support services, health, prevention and wellness, financial management and administrative services, legal fees, expenses for oversight and monitoring, funeral and burial expenses”.

What does that mean for a given person with a disability (and for his or her family)? Who will be good candidates for ABLE Accounts, and who will not? Should you consider an ABLE Account as an alternative to a special needs trust? Those questions — and more — will be addressed in our newsletter next week. Stay tuned.

Uniform Transfers to Minors Act Accounts in Arizona: A Primer

JANUARY 31, 2011 VOLUME 18 NUMBER 4
One question we are frequently asked: isn’t it a good idea to set aside money for a child or grandchild, and isn’t a UTMA (Uniform Transfers to Minors Act) account a simple way to do that? OK — that’s really two questions. Our answers: Yes, it is a good idea to set aside money. Yes, the UTMA account is a simple way to do it. Don’t set up a UTMA account, however, until you understand the consequences.

There are confusing issues about UTMA accounts. Sometimes the confusion is heightened by the fact that each of the 48 states which have adopted versions of the UTMA Act has changed it a little bit — so what is true in Arizona may not be true in another state (and vice versa). Rather than indulge in all that confusion, however, we are going to tell you in straightforward language what to watch for in Arizona. Be careful about applying these principles to other states’ UTMA acts.

First, the good news. Here are the positive things about Arizona UTMA accounts:

  1. They are inexpensive to set up and to administer. They do not require a lawyer, and avoid courts and formal accounting requirements altogether. All you have to do to create an Arizona UTMA account is to include the name of a custodian, the name of the beneficiary, and the letters UTMA in the title. This will work: “John Jones as custodian pursuant to the Arizona UTMA for the benefit of Marie Smith.”
  2. A UTMA account can simplify the gifting of substantial amounts of money by multiple family members. Set up an account for your 2-year-old, and all four grandparents can put $13,000 each into the account each year (using 2011 numbers — the maximum non-taxable gift may go up next year or in future years).
  3. They automatically end at 21, so the money will not be tied up indefinitely. One of the points of confusion: sometimes UTMA accounts end at 18 in other states, and in some circumstances in Arizona. But if you are putting your money into an account for a minor in Arizona, the end date is age 21.
  4. They encourage regular savings by simplifying the process. Open an account with, say, $1,000, and put $50/month into the account. You won’t save a fortune in 15 years, but you will have $10,000 that you wouldn’t otherwise have saved without this discipline. Plus the earnings and growth on the investment, as a bonus.
  5. If the minor receives public benefits like SSI or Medicaid, the money will usually not be treated as “available” (and therefore reduce or eliminate benefits) until age 21.

Of course it’s not all good news. Here are some problems or limitations:

  1. The money in the UTMA account will need to be reported on the minor’s FAFSA (Free Application for Federal Student Aid) form when applying for student aid — and it will be treated as completely available to the student. In other words, the very existence of a UTMA account may prevent receipt of needs-based student aid.
  2. The income in the UTMA will be taxed at the minor’s parents’ income tax rates. Unless, of course, there is so much money in the minor’s name that his or her rate is higher — then the UTMA account will be taxed at that higher rate.
  3. The minor may have to file an income tax return if the UTMA money produces significant income. The UTMA account may be used to pay any income tax due, and the tax preparation costs, but it will require that a return be prepared.
  4. At age 21 the (former) minor is entitled to receive all the money. Period. It doesn’t matter if he or she has become a drug addict, a spendthrift or a cult member.
  5. If the (former) minor receives public benefits like SSI or Medicaid, at age 21 the UTMA account becomes an “available” resource and may compromise those benefits.
  6. If the UTMA custodian is the parent of the minor (which is by far the most common arrangement), then there may be additional complications in how the money can be used and/or what tax effect the money might have. Since a parent has an obligation to support his or her minor children, the UTMA account generally can not be used by a parent/custodian in ways that reduce or satisfy that support obligation. If, on the other hand, the donor of the money acts as custodian, he or she may not have gotten the money out of his or her estate (which is usually one intention on the donor’s part).
  7. Although UTMA accounts are usually seen as simple mechanisms avoiding lawyers and conflict, the custodian still has an obligation to give the minor (or his or her guardian) account information. Thinking of giving a divorced and non-custodial parent money for the benefit of his or her minor child? Know that you are inviting a dispute between the custodial parent and the UTMA custodian over how the money is invested and spent (or not spent).
  8. What happens if the custodian dies or becomes incapacitated? There is no easy mechanism to select a successor custodian; it may require a court proceeding to name a successor. A fourteen-year-old minor may be able to select his or her own custodian, which could raise concerns for a thoughtful donor. (Note: Arizona law does allow the current custodian to name his or her own successor custodian, but few do. If you are planning on setting up a UTMA account, insist that the custodian select a successor.)
  9. What happens if the beneficiary dies before reaching age 21? The money goes to his or her estate — which may require a probate proceeding (if the total is over $50,000 in Arizona) and usually means that the money will be split between the child’s parents. That may be fine, but it may not be what the donor intends or wants.
  10. The effect of interstate proceedings is unclear. If you live in New Mexico and set up a UTMA account in an Arizona bank with an Arizona custodian for a minor who lives in Iowa, what happens when your custodian moves to Wisconsin? What courts might the custodian have to answer to, and whose law applies in the case of a disagreement? Fortunately, this problem seldom arises — there are few legal proceedings involving UTMA disputes. But they do happen, and increasingly so in an increasingly mobile society.

What are your alternatives to a UTMA account? Consider 529 plans for educational purposes, and separate trusts if the money is intended to be for more general use. For a child who earns income an IRA might even be an appropriate choice — if the child earns $3,000 in a given year, he or she can contribute up that amount to an IRA (and the source of the money does not have to be the earnings). Talk to your financial adviser and your lawyer about the cost of the various options, the problems they raise, and the best alternative in your circumstances.

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