Trump Accounts for kids are now available, and there are a lot of considerations for parents who want to open them.
The new type of savings account is a custodial individual retirement account for kids, with special rules until the year the child turns 18. For the next few years, the Trump Accounts come with $1,000 of seed money from the Treasury Department for newborns. That money will grow tax-deferred, with income taxes due upon withdrawal.
The $1,000 is a good deal, but it can also make sense for parents to create the accounts even if their children don't qualify for that money. That is because employers, state and local governments and charities might also make contributions.
For most families, it doesn't make sense to add their own money. Offerings such as 529 savings plans and even taxable custodial accounts are more flexible and have better tax advantages for parents' contributions.
Financial advisers say the best case for adding family money to the accounts could be for wealthy people who have already maxed out 529 savings plans and want to also jump-start their young children's retirement savings.
Who is eligible?
Any child with a Social Security number who is under age 18 at the end of the year the account is established.
Under a pilot program, the Treasury Department is seeding the accounts with $1,000 for children born between Jan. 1, 2025 and Dec. 31, 2028, who have a Social Security number and are U.S. citizens.
When are they available?
The accounts rolled out on July 4, according to the Treasury Department, which is overseeing the program. Banks and other financial institutions are administering accounts. Bank of New York Mellon and Robinhood Markets are managing the initial accounts.
The accounts can be rolled over to other companies. Vanguard, for one, has said it is supporting rollovers.
How do people get an account?
Those with eligible children can elect to open an account by filling out a new IRS tax form, Form 4547, which you can attach to your tax return. There is a box to check if you want to receive the $1,000 seed money. Alternatively, parents and guardians can submit Form 4547 via an IRS online account for individuals.
Another step is needed to activate the account, on the Trump Account app or at Trumpaccount.com, the web version of the app.
What are the investment options?
At launch, all contributions to Trump Accounts are invested in the State Street SPDR Portfolio S&P 500 ETF , a low-cost exchange-traded fund that tracks the performance of the S&P 500 index. The Treasury Department has selected other low-cost index ETFs for the lineup from BlackRock's iShares, State Street and Vanguard.
What are the contribution limits?
Beyond the $1,000 federal seed money, others can contribute to the accounts.
Parents, relatives and friends can contribute up to $5,000 annually in after-tax dollars for years before the year the child turns 18. The amount increases annually with inflation.
Employers can contribute up to $2,500 for an employee or an employee's dependent.
Employers might allow employees to direct pretax salary to Trump Accounts for their employees' children, up to the same limit. Getting that upfront tax break could put Trump Accounts higher on the priority list for where parents put away money for their children.
The Trump administration has been urging corporations, charities and wealthy individuals to contribute to the accounts, meaning that many people qualify to get extra seed money when they sign up.
The Treasury Department said Thursday that philanthropic contributions of stock could go into Trump Accounts, though it didn't provide details on how that might work, as the law requires that investments inside Trump Accounts track indexes.
When can the money be taken out, and how is it taxed?
Taxes are where the accounts get complicated. It depends on who put the money in, how old you are when you take it out and what you're using it for.
You don't pay taxes on dividends and capital gains that remain in the account.
The beneficiary could empty it and use the money for anything on Jan. 1 of the year he or she turns 18. The withdrawals count as taxable income.
As with a regular IRA, there is an early distribution penalty for withdrawals before age 59 1/2 , unless an exception applies, such as using the money for higher education, or up to $10,000 for a first-time home purchase.
Say you accept the $1,000 and you use it for college. Then you pay federal income taxes on the withdrawal of the $1,000 and any earnings. Say you use it to buy a car. You'll also have to pay a 10% penalty.
If you use the money to buy a car after age 59 1/2 , you'll owe income taxes but no penalty.
To make matters even more complicated, say you contributed $10,000 of after-tax money to the account on top of the $1,000 seed money, and there is $4,000 of investment earnings. Any distribution you take will be one-third taxable because the $1,000 seed money counts as earnings, and IRA distributions that include after-tax money are partially taxable. If you take out $6,000 in this case, $2,000 would be taxed, no matter what you use it for and at what age.
You can't cherry pick to take out just the after-tax contributions like you can do with a Roth IRA, said Ian Berger, an IRA analyst with Ed Slott & Co. in Rockville Centre, N.Y.
Contributions from employers and charities have the same tax treatment as the $1,000 seed money.
Do you have to file a gift tax return for contributions?
The IRS recently loosened a gift-tax return filing requirement for most contributors that had been a big complication for Trump Accounts. If the total taxable gifts made by a taxpayer to an individual don't exceed the annual exclusion amount of $19,000, no gift tax return is required.
Should you contribute to a Trump Account?
For parents saving for college, 529 college saving plans offer more substantial tax benefits because the earnings aren't taxable. For older children, as soon as they start earning income, parents can help them set up a custodial Roth IRA. Contributions to those can come out tax-free anytime and are never subject to penalties.
Even an old-fashioned custodial brokerage account can beat a Trump Account if it is invested in a mutual fund with low or no dividends, because the earnings would be largely untaxed until the shares are sold. At that point they would be taxed as capital gains, not as ordinary income, said Gregory Leiserson, a senior fellow at the Tax Law Center at NYU Law.
Contributing to the accounts could make sense for parents who want to get a super early start on their child's retirement nest egg, said Berger, because they offer potentially decades of tax-deferred growth, and unlike a Roth IRA can accept contributions even if the child isn't working. Converting the account into a Roth IRA at age 18 or in early adulthood could provide decades of tax-free growth.
But that is assuming the 18-year-old doesn't cash out.
This explanatory article may be periodically updated.
(END) Dow Jones Newswires