When I was growing up, it was common for children to get a gift of a savings bond from relatives for milestones like your birthday or other occasions. The cool relatives gave you games and toys. Most of my peers that received the bonds couldn’t wait to turn 18 and be able to cash them in to add to their car fund. I was not so fortunate. The accrued interest on the bonds was taxable at redemption. There were no other gimmicks or restrictions.
The Trump Accounts went live this week. Before every parent goes gaga let’s take a closer look at them.
If you are the parent of a child who is or will be born in the years 2025 through 2028, the US Treasury will put $1,000 in the account for each child and Michael Dell is going to add some additional funds if you live in a neighborhood that isn’t considered rich. It’s free money, so accept it – you can’t lose on that. Of course, the Treasury is borrowing this money, so your kids and even their kids will have to pay it back in their taxes.
For them and the rest of the nation’s youth, you can now contribute up to $5,000 per year until the child reaches 18.
Some of the rules are:
- Your contribution is with after tax funds. No deduction.
- Interest and gains are tax deferred and paid on withdrawal.
- Generally, no withdrawals are allowed until age 18.
- The accounts turn into a traditional IRA at age 18.
- Like IRA’s, most withdrawals prior to age 591/2 will be subject to a 10% penalty
- They allow penalty free withdrawals for educational expenses and first-time house purchases, like regular IRAs.
- Withdrawals of interest and gains are taxable as ordinary income.
So, is this a good deal for your kids?
- The account holder gets only a deferral of income taxes which is only the time value of money on the tax that accrues each year.
- The restrictions are numerous.
- Distributed gains are all ordinary income, which is taxed at the highest marginal rates, rather than capital gains and dividends which are taxed at a lower rate.
- IRAs are currently not reported on the FASFA, so it’s likely Trump Accounts will not impair financial aid eligibility.
Everyone is different, but in general, I would say most kids will do better if you put funds in a UGMA account, trust, or just keep them in your name and give them the funds as a gift when they turn 18 or even a bit older. The tax benefits of the Trump Accounts are marginal at best and penalizing at worst. They will have much more freedom and flexibility in other investment vehicles.
At that point they receive the funds the child will have the option of putting the funds in a Roth IRA, using as much of it as they wish toward a home purchase, or even start a business. Of course, there is always the dream car at the local dealership.
The Bottom Line: Trump Accounts May Not Be As Good As Advertised.
–Michael Ross, CFP®
