What to Do with a 529 Plan for Your Child with Special Needs

Many parents open a 529 plan with the expectation that their child will one day attend college or pursue higher education. When a child later receives a disability diagnosis, it is natural to question whether a 529 is still the right savings vehicle. For children with intellectual disabilities (ID) or significant developmental challenges, a 529 may ultimately prove to be a poor fit. That’s because 529 funds are limited to education-related expenses—such as tuition, required fees, books, supplies, and eligible room and board. Most disability-related costs, including therapy, personal care, housing, transportation, and daily support needs, do not qualify. Using 529 funds for these purposes can trigger taxes and penalties, creating unexpected consequences for families.

A common myth is that if the beneficiary is disabled, 529 withdrawals are automatically penalty-free and tax-free. This is not entirely true. While the 10% federal penalty on earnings may be waived when the beneficiary is disabled, the earnings portion of a non-qualified withdrawal is still subject to ordinary income tax. Disability removes the penalty—but not the tax. Only withdrawals used for qualified education expenses avoid both income tax and the 10% penalty. In other words, a non-qualified 529 withdrawal for a disabled beneficiary may be less punitive, but it is not free.

ABLE Accounts

Because of above limitations, families of children with ID often look to ABLE accounts as a more flexible alternative. ABLE accounts are specifically designed to pay for disability-related expenses, and for several years now, families have been permitted to roll funds from a 529 into an ABLE account without triggering taxes or penalties. However, this option comes with important constraints. ABLE accounts are subject to annual contribution limits—$20,000 in 2026—and state-imposed maximum balances. The limit is applicable to rollovers from a 529 accounts as well. Once an ABLE account exceeds $100,000, SSI benefits are suspended until the balance falls below that threshold. In addition, upon the account holder’s death, remaining funds are generally subject to Medicaid payback—a rule many families are unaware of. ABLE funds also legally belong to the individual with the disability, not the parent, which can limit long-term control and flexibility. When overfunded, ABLE accounts can create new tax, benefits, and planning problems rather than solving them. In practice, ABLE accounts tend to work best as spending or near-term support tools, not as long-term accumulation vehicles.

Change the 529 Beneficiary

Another simple and tax-efficient option is changing the beneficiary of the 529 plan. Parents may switch the beneficiary to another qualifying family member, such as another child, without triggering taxes or penalties. For some families, this is a cleaner and more straightforward solution than rolling funds into an ABLE account—particularly when it is clear that the child with disabilities is unlikely to use the funds for education.

Gradual Withdrawals

Yet another way, if education is unlikely a priority for a special needs individual, families may choose to withdraw funds slowly over time rather than all at once. Because contributions come out tax-free and only earnings are taxable, spreading distributions across years can help manage income tax exposure and avoid pushing parents into higher tax brackets.

Parent-Owned Investment Account

Families can consider setting up a separate, parent-owned investment account for their child with special needs. By investing thoughtfully over time—rather than front-loading a large plan—parents can maintain flexibility, control, and preserve eligibility for public benefits. This account can then be directed to a Special Needs Trust after their passing, ensuring the funds are used to support the child throughout their lifetime without the constraints of ABLE limits or education-only rules.

Ultimately, strategic planning is key. Understanding which financial tool best aligns with a child’s abilities, likely educational path, and long-term needs can help families protect public benefits, minimize unnecessary taxes or penalties, and ensure resources are available when they are truly needed. Thoughtful planning allows parents to make the most of both 529 plans and ABLE accounts—while safeguarding their child’s future.

Do you have more questions or need to chat with me? Visit my website -

https://myspeciallegalplanning.com/

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