Avoiding Tax Penalty Due to Disability

SHORTCUTS

529 Plan Details:

Enter your state:

World's Simplest College Calculator:

How old is your child?

Find a 529 Pro:

Enter your zip code:

Enroll In a 529 Plan:

View a list of participating plans

OPTIONS

COLLEGE SAVINGS 101

Avoiding tax penalty due to disability

05/01/2006

QUESTION:
Dear Joe,

I have put off, for far too long, the funding of a college savings program for my two kids (the oldest is now 12). I have always wanted to start a 529 for them, but was concerned that perhaps neither one would ever go to college, as they both have learning disabilities. I saw in a column of yours that the earnings can be withdrawn without penalty (although taxed as ordinary income) if the beneficiary is disabled. So, if both my children are unable to attend college because of their disabilities, would I be able to avoid the penalty?

-- Scott

ANSWER:
Dear Scott,
It's true that distributions made from a 529 plan or Coverdell education savings account because the beneficiary is disabled escape the 10-percent federal penalty tax. The problem you will face is convincing the Internal Revenue Service that your children are "disabled" as that term is defined under the law, should you ever attempt to apply this exception.

According to IRS Publication 970, a person is considered to be disabled if "he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition." Furthermore, according to the IRS, 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."

To examine the definition of "disabled" in more detail, you would have to research the federal tax regulations and court cases involving the same exception as it applies to the 10-percent penalty on early distributions from qualified retirement plans. These will clearly show that an individual's eligibility to use the exception is determined based on the particular facts of the situation. It usually boils down to the effect of the disability on the individual's ability to remain gainfully employed or to return to similar employment in the future.

Obviously, the workplace definition of "disabled" does not translate easily to the situation you are contemplating. Will the 529 penalty exception apply to someone who cannot work because of a disability but who can still study? What if the disability prevents the individual from studying for a degree but not from getting a job? These are the questions that must be asked, but for which there are not yet any clear answers.

If a physician ultimately decides that your child has a disability that prevents his or her attendance at any institution of higher education (including your local community college), you will probably have a good argument for claiming the 529 penalty exception. I suspect, however, that most learning disabilities are not that limiting. You should seek the advice of your own tax professional before deciding to place your money in a 529 plan or Coverdell ESA.

Other recent questions

»529s and Financial Aid (Video) (11/19/2014)
»529s and Financial Aid (Script) (11/19/2014)
»What are the best ways to maximize the savings in my 529 plan? (Video) (10/14/2014)
»What are the steps involved in setting up a 529 account? (Script) (09/15/2014)
»What are the steps involved in setting up a 529 account? (Video) (09/15/2014)
»What is the first step in getting started with a 529 plan? (Script) (09/05/2014)
»What is the first step in getting started with a 529 plan? (Video) (09/05/2014)
»Coverdell ESA vs. 529 Plan: Which to choose? (Video) (07/15/2013)
»Coverdell ESA vs. 529 Plan: Which to choose? (Script) (07/15/2013)
»What is the best 529 plan for me? (Video) (07/10/2013)
»What is the best 529 plan for me? (Script) (07/10/2013)
»What happens to my 529 if my child gets a scholarship? (Video) (07/02/2013)
»What happens to my 529 if my child gets a scholarship? (Script) (07/02/2013)
»Can grandparents open a 529? (Video) (06/20/2013)
»Can grandparents open a 529? (Script) (06/20/2013)
»Do I have to use my own state's 529 plan? (Video) (06/12/2013)
»Do I have to use my own state's 529 plan? (Script) (06/12/2013)
»529 Plans: Tax Benefits of a 529 Plan (Video) (06/07/2013)
»529 Plans: Tax Benefits of a 529 Plan (Script) (06/07/2013)
»What are the Pros & Cons of 529 plans? (Video) (05/30/2013)

My College Savings


Help us personalize our site for you.

1. I am a ...
Please select an option.
2. My child is ...
Years Old
Please enter the age of your child.
3. I have a 529 plan for this child
Please select an option.
 

Reset email successfully sent.
Please check your inbox.

Close
page loadtime mark

Advertisement


close