Pursuing tax-advantaged savings in special needs planning
By Rob Wrubel, CFP®, AIF®
Do you know what keeps me on edge and worried about the planning work that I do with families with a special needs member? Where do I start? The list is fairly extensive.
The biggest worry is making a recommendation that could damage a person’s ability to qualify for Supplemental Security Income or Medicaid as a result of their income or resources. I have seen this happen from the work of advisors who are not aware of the special issues facing families like ours. Fortunately, reasonable planning steps can be taken to help create long-term financial resources and keep those assets protected from counting as a financial resource for qualification.
One of the great difficulties facing special needs family members is to find tax advantaged savings and education planning accounts that could be used to support the special needs person. Life insurance is sometimes used as a tool to provide tax-advantaged savings. Unfortunately, most life insurance vehicles have serious drawbacks including a lack of liquidity and relatively high expenses. Most of the time when I see life insurance in the special needs plan it has not been funded correctly and does little to help create usable assets for the special needs person during his or her lifetime.
A few years ago, there was some momentum in Congress to pass the Achieving a Better Life Experience (ABLE) Act. The ABLE ACT would have allowed for the creation of tax-advantaged accounts for people with certain disabilities. These accounts could be funded with after tax dollars, then grow on a tax-deferred basis. The money could come out without paying taxes on growth if it went towards certain special needs expenses – like transportation, medical care, employment support and more. Unfortunately, the ABLE ACT looks like it will not soon be passed. This bill has had bipartisan support (a rarity these days). The reality is that people with special needs are invisible in Washington. Take a moment to email your Congress members to let them know you want this bill passed.
Roth IRAs can also be a fantastic way to save for future special needs expenses if handled correctly. The money in the Roth account grows on a tax-deferred basis and will likely come out without any taxes. The estate features on a Roth are more favorable than traditional retirement accounts as the deferred taxes do not have to be paid when this account is transferred upon death to another generation. One challenge here is that these accounts should not be held in the special needs person’s name. A Roth IRA (or any retirement account) titled in the name of the special needs person will cause a loss of eligibility if that account and others total more than $2,000.
Most of the time, we cannot find a great way to save money in a tax-advantaged account that can used specifically for the special needs person’s expenses and is clearly marked for the special needs person. The tools we have available to create resources must be kept in the name of someone else most of the time. This often works but we still have some creditor protection issues to worry about.
The special needs trust can also be funded, if done correctly. Many times, this is not the case and the tax and legal issues ruin the ability to transfer resources to the trust to benefit the special needs person. Additionally, special needs trusts often pay more in income taxes than the person or people funding them.
You can see the dilemma. In a perfect world, we want to transfer assets to the special needs person or a trust for their benefit. We want to gain some tax preference for this trust, some creditor protection and make sure the funds are designated and used for the special needs person.
The most confusing element comes in the form of a 529 plan. A 529 plan is the name we use to refer to a form of savings that can be used for college and higher education. The account is funded with after-tax dollars and can grown tax-free is the money is used for certain education expenses. It is the type of plan I usually recommend to families looking to save for college.
The 529 is different than an IRA, bank account or other financial asset. Technically, the owner of the 529 plan can be a parent or other family member of the person with special needs. The owner can name another family member as beneficiary, and reserves the right to change beneficiary or close the account at any time.
529s with special needs person used to be considered a resource of the special needs person, much like an IRA, bank account or other account would be. Now, the language used to guide the employees of the Social Security offices has changed. The door has been opened to using a 529 plan as a savings vehicle if you expect your special needs family member to attend some institution of higher education.
Today, many parents of special needs children are looking at colleges for their special needs family member. There are places throughout the country that provide a college experience for people with developmental disabilities. Our society has learned not to put pre-determined constraints on people with different types of developmental disabilities. How can we tell at age three if the child born with autism or Down syndrome will have opportunities for education 15 or 20 years from now? Why shouldn’t we have funding in place that could be used for those situations?
The 529 plan does present some serious drawbacks. Funds coming from the 529 plan must go to be used for tuition, fees or other education expenses or it will be considered income. Funds that come out of the plan must spent for education purposes within nine months of withdrawal from the 529 plan or it will be considered a countable resource.
We would love the ability to save for future special needs expenses and gain some tax-advantages to get there. We have decided as a society that retirement savings deserve some form of tax help – and the entire industry of 401(k), 403(b), IRA and Roth IRA was created. Special needs planning does not have any obvious place to go where expenses can be low, tax-advantages high and where long-term dollars can be asset protected. Call if you need any help navigating through the complex world of saving for your special needs family.
Rob Wrubel, CFP,® AIF® is a Senior Investment Consultant with Cascade Investment Group, member FINRA & SIPC. Cascade Investment Group is not a tax or legal advisor. You should always consult with your tax advisor or attorney before taking any actions that may have tax consequences.