Was it the Superbowl ad? Trump Accounts have garnered attention lately. Maybe Superbowl ads do work? Or it might be because it's tax season and starting this year, if you qualify, you be able to open a Trump Account when you file your income taxes. Either way, if you're wondering what is a Trump Account, here's how I think high-income professionals may find these accounts useful:
First some background, so what are Trump Accounts?
A good place to start is with TrumpAccounts.gov, to read more. The goal is to "build long-term financial security for millions of children" by helping our children save for retirement, according to the website.
Trump Accounts are investment accounts created for minors who have a valid social security number and are under 18. You can contribute up to $5k a year per child and there are no mandatory contributions. Starting in the year the child turns 18, the account becomes the child’s account.
What to consider?
Here's what I think you should know:
- Investments are not guaranteed – Money is invested in index equity mutual funds, consisting mostly of US stocks.
- Earnings grow tax-deferred, not tax-free, meaning withdrawals are taxable, but dividends and interest while inside the account are not taxed until withdrawn.
- Withdraws may be subject to restrictions - There may be some ability to access the funds without penalty at 18 for education, start a business, or first-time homebuyer, but the earnings are still taxable. Since the contributions are made with after-tax dollars, only the earnings are taxable. There is a 10% penalty for non-approved expenses prior to the child's age 59 1/2.
- Account transfers to child at 18 – Let’s hope junior doesn’t squander the money!
- Accounts can continue to be invested beyond the child's age of 18, and do not need to be withdrawn.
Trump Accounts vs. 529s
If you are comparing college saving 529 plans to Trump Accounts, here are some things to consider:
- Annual contribution limits are higher for 529s than Trump Accounts
- Qualified education expenses can be withdrawn tax-free with 529s but not with Trump Accounts, the earnings are still taxable even for qualified withdraws.
- Trump accounts have special provisions for purchasing a first house or starting a business, unlike a 529. With a Trump Account the penalty for pre-59 1/2 withdraws may be waived under these special circumstances, but the earnings are still taxable.
"It all boils down to the objective and the parent's disposable income. It might not be an either/or decision, but some combination."
My Take
Trump accounts, which are comparable to a child IRA, can be beneficial for a child's retirement. I like how Trump Accounts use inexpensive index equity mutual funds. This should help the account grow over time, especially if the child holds the account until his or her retirement. Keep in mind there is no guaranteed return on equity mutual funds, so accounts can lose value.
A Roth IRA is a nice option for kids who wish to contribute and are already employed. Qualified Roth IRA withdraws are income-tax free (qualified can mean the account is open for five years and the distribution occurs after 59 1/2 among or a one-time qualified first-time home purchase up to $10,000).
One of the major differences between Trump Accounts and Roth and regular IRAs is if a child has no income, parents can still contribute to a Trump Account. That is unlike in a Roth or regular IRA which require the account owner to have earned income.
It all boils down to the objective and the parent's disposable income. It might not be an either/or decision, but some combination of all the above. One might want to contribute to Trump Accounts to help kickstart a young child’s retirement and fund 529s for their child’s higher education. If the child is working part-time, he or she can still contribute to a Roth IRA (limits may apply) and those contributions will not interfere with the parent’s ability to fund a Trump Account and/or 529.
I also have clients who purchase life insurance on their children for a variety of reasons such as ensuring their children will have some basic death benefit protection when they grow older. With so many options to choose from, I can’t emphasize enough the importance of having a written financial plan and working with a qualified tax and/or financial advisor who can help you navigate all these choices.
If you want to learn more about financial planning, please email me at maloi@sfr1.com