Considerations for a 529 Plan with a “Disabled” Beneficiary


A 529 plan is a tax-advantaged savings account designed to pay for a child’s eventual educational expenses. Money in a 529 plan is used for a wide range of educational expenses, including college tuition, K-12 private school, certain apprenticeship expenses, and even student loan repayments. Many families create a 529 plan to reduce the student’s debt burden post-graduation.

As we all know, sometimes life doesn’t go as planned. Many families  with 529 plans later ask what can be done with the funds when a beneficiary is “disabled” and unlikely to pursue higher education. Withdrawing all the funds from a 529 plan has adverse tax consequences. Any earnings are subject to federal income tax, possible state and/or local taxes, and a potential 10% federal “penalty”.

If you created a 529 plan for a disabled child who is unlikely to use the funds, there are options other than enduring a hefty tax and penalty hit.

1. Determination of “Disabled” by the IRS

You generally have to pay a 10% penalty (plus income taxes on earnings) if your 529 plan withdrawal is not for a qualified educational expense.  You may be able to withdraw the money for non-qualified expenses without a penalty if the beneficiary meets the IRS’s definition of  disabled. According to the IRS, the 10% penalty does not apply when the distribution is made “because the designated beneficiary is disabled.”

The IRS defines a “disabled” individual as follows:

A person is considered to be disabled if he or she shows proof that he or she can’t do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.

Because 529 plans are self-reporting, you bear the responsibility to make the claim that the beneficiary is “disabled.” For more information, visit Publication 970 of the Internal Revenue Service at this link.

However, even if the beneficiary meets the definition, income tax on the earnings still applies.

2. Changing the Beneficiary of the 529 Plan

You may consider changing the beneficiary to a sibling or another eligible relative who can use the money in the 529 plan for education. That way you can avoid the penalty and income tax. Eligible family members are defined as close members of the beneficiary’s family, not the donors. The eligible members include a beneficiary’s child, sibling, half- or step-sibling, parent, step parent, niece, nephew, uncle, aunt, or spouse.

Changing the 529 plan’s beneficiary to someone who is not an eligible family member is treated as a “nonqualified withdrawal.”  Before taking action to change the beneficiary of a 529 plan you should consult with a qualified tax advisor about the tax consequences.

Note that the beneficiary of a custodial 529 plan account cannot be changed.  Custodial 529 plan accounts are often referred to as as UGMA or UTMA accounts. These differ from traditional 529 plan accounts because the funds are invested on behalf of minors who become owners of the account once they come of age.

3. ABLE (Achieving a Better Life Experience) Accounts

Another option to consider is transferring the money from the 529 plan into an Achieving a Better Life Experience (ABLE) account. The ABLE Act of 2014 provided individuals with disabilities the opportunity to save up to $15,000 per year in a tax-deferred account. These tax-advantaged savings can are used for disability-related qualified expenses. Like a 529 plan, ABLE accounts allow a tax advantaged way to save and pay for disabled individuals qualified expenses, without jeopardizing eligibility for critical government benefits.

Annual contributions to ABLE accounts must not exceed the federal annual gift tax exclusion ($15,000 in the year 2021). When transferring money from a 529 plan into an ABLE account, you will need to abide by this annual contribution rule. To illustrate, if you have $60,000 in your child’s 529 plan, you will need to have a 4-year plan to transfer the money from the 529 plan to the ABLE account (assuming no change in value of the 529 plan and no other contributions to the ABLE account).

Section 529 of the Internal Revenue Code allows rollovers from a 529 plan account to an ABLE account for the beneficiary or a member of the beneficiary’s family, without incurring federal tax or penalties. Further, such rollovers will not be subject to New York state taxes or tax penalties. To be tax‐free, such rollovers must meet certain requirements, which should be discussed with a tax advisor before initiating a rollover.

Importantly, this method of transfer is available for custodial 529 accounts. Therefore, even if the beneficiary of a custodial 529 plan cannot be changed, money in a custodial account can be transferred to an ABLE account.

For more information on New York’s ABLE Program, visit

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Burner Law Group, P.C.

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