With the July 4th launch of the newly created Trump accounts, we wanted to share our thoughts on what they are, pros and cons, and alternative savings options you have.
What are Trump accounts?
Trump accounts are tax advantaged savings accounts (like Traditional IRAs) for children. Parents, grandparents, family members, or friends can contribute up to $5,000 per year total for a minor. There is a limitation for one Trump account per child.
The funds are invested in a stock market index and grow tax deferred. When the child reaches 18, the account is placed in the child’s name only and treated like a traditional IRA. The child can start contributing to the account, leave it to grow, or use the funds.
Withdrawals work the same way as traditional IRAs. Any distribution before the age 59 ½ is subject to ordinary income and 10% penalty tax for the child. There are a few exceptions that waive the penalty tax like first time home purchase or higher education expenses. After 59 ½, the distributions are just subject to ordinary income taxes.
Trump accounts offer some additional benefits. For example, children born between January 1, 2025 through December 31,2028 can receive a one-time $1,000 contribution from the government. Employers can contribute up to $2,500 for their employees’ children.
What are the drawbacks to Trump accounts?
There are a few things to consider before opening a Trump account.
- Trump accounts transition to kids once they turn 18. This means your 18-year-old may have access to a significant amount of money. Not every 18-year-old is prepared for the level of responsibility, and there’s unfortunately no way to limit the child’s access to the money.
- Trump accounts offer no early access to the funds. Funds cannot be withdrawn early even if needed for education or emergencies. If the child dies, the earnings become taxable to their beneficiary.
- Trump accounts may impact FAFSA benefits. Trump accounts would be considered an asset of the student thus reducing their eligibility for need based financial aid.
What are options other than Trump accounts?
529 educational accounts offer many tax advantages and provide more flexibility for account owners.
- 529 accounts can be invested and used tax free towards education expenses. $10,000 per year can be used for K-12 education expenses. Trump accounts cannot be touched during these years.
- Leftover funds can be used for another beneficiary, rolled into a Roth IRA (max of $7,000 per year with $35,000 limit), or withdrawn for general use. Non-education withdrawals are subject to income tax on the earnings and a 10% tax penalty.
- You can change beneficiaries on 529s at any time. This way, if your teenage child turns out to be an irresponsible adult, you can divert their 529 to other family members or even back to yourself.
Another option is UTMA accounts. UTMA accounts allow adults to hold accounts for a minor and transition the assets to a minor when they turn 18-25 depending on state law.
- A major benefit of UTMAs is the funds do not need to be used strictly for education and can be used before the child reaches 18. UTMAs can help a child with a car purchase, home purchase, or starting a business.
- Like Trump accounts, a similar drawback of UTMA accounts is the minor gets access to the account without restriction when they reach the age of majority.
- UTMAs can create tax complications through the kiddie tax if the assets earn too much income.
A third option is to gift the child assets (cash or stock) as they grow older. This will give you total flexibility to gift money to a child when they are responsible enough to manage the assets or reward their accomplishments.
Which account is best?
This depends on your situation and goals.
- If your goal is to save for a child’s education, 529s are your best bet due to the tax advantages, control, and flexibility with leftover funds.
- UTMA or brokerage accounts in your name allow for savings for things outside of education.
When does it make sense to use Trump accounts? If you qualify, the free money is a reason to choose a Trump account over a 529 plan. If your child is born during the appropriate time frame to receive free government funding or if your employer is going to give your child funding, you should consider opening a Trump account.
The bottom line is Trump accounts are not meant to replace any existing accounts but rather create a new savings option for children. Which one makes the most sense entirely depends on your situation.