529 Plan Assets Can Collide With Medicaid Eligibility

“Section 529 plans,” named after a section of federal tax code, are an appealing way for grandparents or others to fund a child’s college education while retaining control over the funds. The gains on fund investments build tax free, and the beneficiary of the plan (the child) pays no tax on withdrawals from the account as long as the funds are used for his or her qualified educational costs.

But in an article in The Buffalo News, elder law attorneys warn that 529 plans can have serious pitfalls for senior investors. This is so because savings in a 529 account can cause a collision with Medicaid rules, in the event the account holder requires long-term care.

“Say if you have a stroke and need nursing home care, the 529 account is an available asset” under Medicaid rules, says Bruce Reinoso, an elder law attorney at Magavern, Magavern & Grimm in Buffalo and an ElderLawAnswers member.

This means money in the 529 account must be exhausted before Medicaid will pay nursing home bills. Worse, spending the money in the 529 account for medical bills instead of college will trigger deferred taxes, plus penalties of 10 percent (or up to 20 percent in some states) that apply if the money is used for something other than education.

The collision with Medicaid rules has been felt by some seniors across the state, says former ElderLawAnswers member Bernard A. Krooks, who is an elder law attorney in New York City and president of the National Academy of Elder Law Attorneys. “This is something that is a great source of concern for seniors,” Krooks said.

One solution is to legally shift the account to a family member of the beneficiary, such as the grandchild’s parents. But not only does the former account holder lose control of the money, but such a transaction is considered a transfer of assets that triggers a Medicaid penalty period.