Special Needs Financial Planning During COVID
2020 is finally behind us. Unfortunately, COVID-19 and the financial results are not. What can we do going forward to get through what will most likely be another difficult year?
First, we need to understand the rules. You and I didn’t create these rules, the government did. There is a rather lengthy rule book available to us: The Internal Revenue Code. That’s our playbook, and financial planning needs to account for those rules. Ever play a board game at your house under the rules as you understand them, and then play it somewhere else with a different set of rules? What happens in Monopoly when you land on free parking? Some people put money in “the kitty” from the start of the game, and others start with no money in free parking, but all the money players pay to the bank goes into that pot. Well, those aren’t the rules. Free parking is just what it says it is: Free. You can’t own it, nor can anyone else. It’s just free parking.
In life, we don’t get to change the rules of the game. The government tends to frown upon that. There is very little, if any, free parking in life. The best way to get ahead is to know and understand the rules our government has provided for us. The tax code itself isn’t that long, coming in only around 2,600 pages. It has roughly more words in it than the entire Harry Potter book series. In addition to those pages, you have statutes, regulations and caselaw. This ends up being a pretty long, complex rulebook without any of the fun Harry Potter provided.
So where does that leave us? I’m going to try to help make some of the information easier to understand. Our goal is to provide for our families. 2020 created so many new and unique challenges; from businesses closing (permanently or temporarily), schools shutting down, income evaporating; one may think, where to even begin? We simply need to find a way to get the most bang from our buck. To do this, let’s discuss some basics on different options we have, and a concept called bucket planning. PLEASE NOTE: The information that follows is general in nature. It’s not my aim to provide tax advice. Please consult your tax professional regarding the general concepts discussed here.
We can break down bucket strategy into three categories. The general concept revolves around when we anticipate needing access to our money, and the categories are short-term, mid-term and long-term planning. Think of your checking account as a short-term bucket. Between checks and a debit card, we have access to that money any time we need it. A savings account would fall into the mid-term bucket. We have that money for emergency planning, or saving up for a vacation or larger purchase. Our retirement plans tend to be in the long-term bucket, which traditionally limits access to the funds by way of taxes or penalties depending on age.
To make this strategy as effective as possible, we want to utilize plans that can allow money to be moved between buckets without penalty. The CARES Act was passed in 2020 to provide economic relief to both business and families and allows access to plans that would otherwise come at a cost. Under normal circumstances, there are rules that need to be followed in order to maintain the beneficial tax treatment of that money. However, there is no word as of now on whether these options will continue to be available in 2021. We need to find a way to set money aside that can be used in any of these buckets as needed.
What are the options?
Roth IRAs are typically used as retirement accounts, which puts them in the long-term bucket. However, if needed, some to all of that money can be used in either the short or mid-term buckets, as well. There are two types of distributions that can be made from your Roth IRA. Good (qualified, no taxes or penalties), and bad (Non-qualified, taxes on growth and penalties.) We’ll focus on the good. First off, the magic age is 59 ½. Distributions after that age are qualified, so no need to worry. Distributions prior to that age used for the purchase of a new home, covering qualified medical expenses (including premiums), or for higher education expenses are exempt from penalties. Taxes are still due on any gains. You can access your original contribution from your Roth at any time, tax-free and without penalty.
Roth contributions and conversions (back door) are available for families that make more than the income limit, as well as for existing traditional accounts.
Utilizing this type of account will not only allow for money to be set aside for retirement, but can also be used for short and mid-term planning as well.
ABLE and 529 accounts provide for a unique combination, as well. Many here are familiar with ABLE accounts and how they can be used for “qualified disability expenses.”
ABLE accounts are part of IRS code §529. There’s that code again! Most people know section 529 as a college funding account. However, using both 529s and ABLE accounts together can allow for preferential tax treatment and options, as well. Under typical circumstances, we would contribute to the 529 plan to provide for future education expenses. If medical expenses for our child became overwhelming, we can move money from the 529 plan to an ABLE account, and use that money as needed. The limitation on this is the annual contribution limit for ABLE accounts, which is $15,000 per year. Typically, 529 plans would fall into the mid-term bucket, but again, the money can be used for short term expenses, if needed.
Raising children with special needs during the COVID era is a unique and ongoing challenge. In order to get through this, we need to look at some options to set money aside for the future, as well as having access to it sooner, in case something comes up. We will all need money in the future, but traditional planning can lock that money up for years or cause significant taxes and penalties to become due if we need immediate access to the funds. We need to understand the rules of the game we are playing, and how we can best utilize those rules to allow our money to be used in multiple buckets.
More Helpful Articles on Financial Planning
A Special Need Planning Timeline: 9 Steps to a Sound Family Plan
Creating a Financial Game Plan | A Milestone-Based Guide to a Special Needs Plan
Common Mistakes Parents Make with Their Special Needs Trusts
Jeffrey S. Light, ChSNC™
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