Faced with the increasing cost of higher education, students and their families must begin saving for college from an early age -- often from birth. 529 College Savings Plans offer families a great opportunity to set aside money for a child's college education, especially since funds held in 529 Plans grow tax-free. However, when a child with special needs is setting aside money for college, a 529 Plan may not be the best option. Given the increase in population diagnosed with special needs and the leveling of government funding, the important thing is to plan or save for an individual with special needs; regardless of the funding vehicle!
Here are some things to think about when family members ask about the best way to provide funds for a child with special needs' college education.
How Does a 529 Plan Work?
529 College Savings Plans are named after a provision of the tax code, and for good reason -- these savings accounts provide a substantial income tax benefit to the account beneficiary. Basically, a 529 Plan is a specialized account established for the benefit of someone who is planning to attend college. Anyone can create the 529 account for a relative, and once the account is created, anyone can contribute to it, with gifts into a 529 account qualifying for the $14,000 annual gift tax exclusion. But the best feature of a 529 Plan involves income tax savings, since all of the funds placed into a 529 account grow free from income taxes so long as they are spent on qualified educational expenses. For example, if parents fund a child's 529 Plan with $30,000 at birth and those funds grow to $60,000 by the time the child has reached college, there will be no income tax on the $30,000 gain in value. Because of this significant tax advantage, many families set up and fund 529 accounts when their children are young in order to obtain the best value over time.
As mentioned above, the main advantage of a 529 Plan is that it provides the opportunity for tax free savings if the distributions meet the definition of the plan’s qualified college expenses. Generally speaking, the sooner the funds are in the account, the longer the funds will be set aside for growth potential. Unfortunately, the timing for college planning for individuals with disabilities is challenging because the younger a child is, the greater the uncertainty regarding college as an appropriate opportunity.
Another consideration in choosing a 529 Account is whether the child with special needs has siblings. If they will not need the funds for college, the funds may be transferred with no penalty to a sibling.
How Do 529 Plans Affect Someone's Government Benefits?
Some government benefits, like Supplemental Security Income, have very strict income and asset limits. Because of these restrictions, it is vitally important that the 529 account is not owned by the person with special needs. Furthermore, if the 529 account was set up when a child was younger and it becomes clear that the child is not going to need the funds in the account for a college education, the funds should not be withdrawn and given directly to the person with special needs. Not only can such a gift cause a loss of government benefits, but the distribution for a non-qualified expense triggers state and federal income taxes and a 10 percent penalty for spending the 529 funds on something other than a college education. Because some of these problems can be avoided through the use of other savings devices, it is important to talk with a qualified special needs planner before creating, funding or spending money from a 529 Plan for the benefit of a child with special needs.
What Other College Savings Options Are Available for People With Special Needs?
An alternative to a 529 Plan is to simply fund a properly drafted special needs trust for the benefit of a person with special needs. Anyone can establish a special needs trust for the benefit of a child with special needs, however the funds in the trust do not grow tax-free. The trust is treated as a separate taxable entity and requires an annual tax return. For this reason, many times trusts are funded at upon the death of a parent(s).
On the plus side, a special needs trust provides much more flexibility than a 529 account in terms of spending the trust assets for the benefit of the child. While a donor may not be able to guarantee that the funds held in the trust will be used entirely for education, there are mechanisms that can be put into a special needs trust to ensure that a child's educational expenses are taken into consideration when funds are distributed, and the donor of the trust can retain some powers over how distributions are made.
Another way to save for college is for parents or grandparents to establish a savings or investment account in their own names and then simply spend the funds in that account for the college education of a child with special needs. Since payment of educational expenses by a third party does not trigger a loss of benefits, this option avoids potential conflicts in terms of account ownership. However, the funds in the account will still belong to the donors, limiting the estate and income tax benefits that make contributions to a 529 Plan so appealing.
If you are interested in setting funds aside so that a person with special needs can attend college, it is important to act as soon as possible. A qualified special needs planner can assist you in mapping a college savings strategy that is right for your family.
We are proud to be amongst the first financial planning members of the Academy of Special Needs Planners in the US. This article appears in it's original form on the Academy webiste. We have supplemented the material with additional information and suggestions for our readers.