529 Essentials: 529 Plans & ABLE Accounts

This week, we will compare and contrast 529 plans and ABLE accounts.

529 & 529A Investment Vehicles: 529 plans and (529A) ABLE Accounts. Both investment vehicles allow families to save for their children and grandchildren. While 529s are known for providing tax-advantaged savings for higher education, the goal of the newly launched ABLE programs is to provide tax-advantaged savings accounts for certain individuals with disabilities and their families, while safe guarding eligibility for means-tested federal benefits. For both types of accounts, after-tax contributions grow tax deferred and distributions from the accounts are tax exempt when used for qualified expenses. Despite some similarities due to ABLE programs being modeled after 529 college savings plans in terms of structure, there are significant differences. For example, qualified expenses differ as they are intended for different goals. For simplicity, this article will stay centered on introductory 101 information as a means to help pivot those that are familiar with 529 college savings plans to better understand ABLE accounts. The next section provides an update on market sizing, before providing an overview of how to compare and contrast the two investment vehicles. Therefore you as an advisor can provide value by knowing the pros and cons of these investment vehicles, selecting the right investment vehicles based on the unique needs of your clients, and executing a customized plan based on your knowledge of the investment vehicles and the needs of your client.

Market Sizing: As of December 2015, 529s allowed 12.7 million families to save over $253 billion in assets based on data by Strategic Insight. Of that, 11.6 million families saved over $230 billion in 529 savings plans while 1.1 million saved over $23 billion in 529 prepaid accounts. In addition to the $253 billion in 529s, families have opened approximately 1,000 accounts as of the second quarter of 2016 given the recent availability of the accounts. While the ABLE legislation was signed by the President on December 19, 2014, the first program offering the new investment vehicle was launched in June 2016. Therefore assets in 529s for college financial planning represent a significant amount of assets, and assets and number of accounts in ABLE programs represent the start of the new opportunity for advisors.

Compare and Contrast:

—Income Limit: 529 plans and ABLE programs do not have an income limit or restriction. For ABLE programs, assets in the accounts will receive favorable treatment when determining eligibility for most federal means-tested benefits. For example for SSI only, the first $100,000 in ABLE account assets will be disregarded while amounts over $100,000 will create an impact on eligibility. Alternatively, Medicaid benefits are not impacted by asset levels in ABLE accounts.

—Age Restrictions: 529 plans do not have an age limit or restriction. For ABLE programs, eligible individuals must be disabled before age 26. While this age qualification is as of publication of this article, the ABLE Age Adjustment Act is seeking to raise the age of onset limit from 26 to 46. Additionally to be eligible for ABLE programs, the individual must self-certify that they have a qualifying physical or mental disability diagnosis from a physician that has lasted or is expected to last at least a year.

—Contribution Limits: 529s allow investors to contribute up to the annual gift taxing limit of $14,000 per year per account-owner beneficiary relationship, or $28,000 per joint filing married couple as of 2016. 529s allow an accountowner to make five years of gifting in one year such as $70,000 per single filer or $140,000 per joint filing married couple, and allow a sizable maximum account size that aligns with the cost necessary to provide for the qualified education in a state, which is typically more than $300,000. Lastly, assets in 529s are removed from the taxable estate. ABLE accounts allow total annual contributions up to the federal gift tax exclusion amount of $14,000 per account, and the contributions may come from multiple individuals. Over time, the maximum account balance for an individual ABLE account cannot accumulate to exceed the state limit on 529 college savings plans. Also, an account may be opened with any state’s ABLE program offered nationwide, as investors do not need to use the ABLE account offered by their state of residence. Lastly, ABLE accounts do not provide for five year accelerated gifting as allowed for 529 savings plans.

—Tax Benefits on Contributions: For both types of accounts, after-tax contributions grow tax deferred and distributions from the accounts are tax exempt when used for qualified expenses. For 529 plans, residents in over 30 states plus D.C. receive a state tax deduction or credit for contributions into a 529 plans though there is currently not a federal tax deduction for contributions into 529s. For ABLE programs, a number of state agencies are also working to implement state tax incentives on contributions into ABLE programs as well.

—Market Risk & Cost: 529 college savings plans and ABLE accounts allow parents to self-direct their investments among a menu of options, and therefore adjust their level of risk. While the majority of assets in 529 college savings plans are in target-date funds, the majority of assets in ABLE accounts are in target-risk investments and bank accounts.

—Investment Changes: 529s and ABLE accounts are granted two investment changes per year.

—Account Control: 529s allow the accountowner to maintain control of the account, and allow for an unlimited number of rollovers if the beneficiary is changed to a member of the family of the previous beneficiary. Therefore, 529s allow changes in beneficiaries while the accountowner maintains control of the account. ABLE accounts allow each eligible individual to have only one account, and the eligible individual of the account is also the account owner in all cases. ABLE accounts allow rollovers to family members, though the definition of a family member is more restricted.

—Financial Aid: 529 assets increase expected family contribution (EFC) by 5.64%, but distributions from 529s do not impact EFC. Based on current language and interpretation, ABLE accounts do not have an impact on financial aid.

—Qualified Expenses: For both types of accounts, after-tax contributions grow tax deferred and distributions from the accounts are tax exempt when used for qualified expenses. 529 savings plan assets can all be used for any qualified higher education expense such as tuition and fees, supplies and computer technology for the vast majority of colleges and universities in the U.S. and many abroad so long as they are eligible for financial aid from the U.S. Government. Otherwise, the gains portion of the 529 distributions are subject to a 10% penalty and taxes. There are exceptions to the penalty, as covered in a previous issue of the 529 Dash. Assets accumulated in ABLE accounts may be used for a broad definition of qualified disability expenses. The two stipulations are that the expenses relate to the individual’s disability or blindness, and are for his or her benefit. Items that may pertain to this definition include: Education, housing, transportation, employment training and support, assistive technology and services, health and wellness, financial management, legal fees and funeral expenses. While the list is not exhaustive, the purpose of the expenditure should be consistent with the intent of ABLE accounts.

—Distribution Restrictions: 529s allow distributions to the school, accountowner or beneficiary. For ABLE programs, the eligible individual is also the account owner. Though ABLE accounts allow for an authorized person, there is no successor owners allowed. Lastly, the accounts may become frozen during periods of ineligibility. For amounts still in the account upon the death of the beneficiary, the “Medicaid Pay-Back” provision may claim a portion of the amount as a means to recoup the cost spent on the beneficiary by the state on its Medicaid program.

Therefore, advisors, accountants and estate planners should understand the key product features of 529 plans and ABLE accounts, how the two types of plans function independently and ensure the most appropriate investment vehicle is used for your clients given their specific needs.