It is possible that an individual, once diagnosed as a person with special needs, sometime in the future will no longer qualify as “disabled” according to IRS regulations. The individual's condition might have improved through remission or medical treatment, for example, or perhaps the original diagnosis was inaccurate. If an ABLE account had been set up for the person with special needs, what happens to it in such cases? Here are several key questions to understand the timetable and options available.
Does the beneficiary still have access to her ABLE account?
Yes, but only for a limited time. The account can remain open and active until the end of the calendar year in which the change in status took place. Up until that date, contributions can go into the account and distributions can be made from it, as if the beneficiary were still eligible.
What happens to the ABLE account going forward?
At the end of that calendar year, the beneficiary is no longer eligible and loses the tax-favored benefits of the ABLE account. Contributions can no longer be made to the account, and any withdrawals are considered nonqualified distributions. Such withdrawals may also affect the person's eligibility for government benefits, such as Supplemental Security Income (SSI).
Will distributions from the ABLE account be subject to income tax once the beneficiary is no longer qualified?
Any distributions that include returns on the account, such as investment growth or interest and dividend income, are subject to federal income taxes. Note that the tax on such distributions is increased by 10 percent over the tax rate that would normally apply. State and local taxes may also be a factor.
What are some strategies for spending down money during the calendar year before the ABLE account becomes inactive?
Once all of the money is withdrawn, the ABLE account is closed. But the money must be spent according to IRS regulations to avoid being subject to income taxes or the risk of losing eligibility for government benefits. One strategy is to spend as much of the funds as possible, before the end of that calendar year, on qualified disability expenses (QDEs) such as employment training and support, housing, transportation, and assistive technology.
Can state governments claim funds from an ABLE account after the beneficiary's death, even if that person was deemed no longer eligible because of medical improvement and the account is inactive?
Yes, if that person, while disabled, also received money from state-run Medicaid programs. For this reason, people who have lost their eligibility due to medical improvement might choose to spend down and close their ABLE accounts within that first calendar year rather than keep it inactive going forward.
If you or a loved one has a change in disability status that affects an ABLE account, speak to your special needs planner.