A new type of investment account is coming July 4 that seeks to give younger Americans a head start on saving for their retirement.
Trump Accounts are quasi-individual retirement investment accounts that can be opened on behalf of minor children (called beneficiaries) by their parents or guardians. The accounts provide for tax-deferred growth over their working lifetimes and may also help develop positive investing skills by giving young savers skin in the game.
Parents can open a Trump account for each child under age 18 and contribute up to $5,000 per year toward the child’s future retirement. The accounts can also accept funds from other individuals, employers and charitable organizations and include a four-year pilot program featuring a $1,000 government kicker for eligible kids born during a period coinciding with the current administration.
Trump accounts are hybrid creatures with lots of complicated rules.
Accounts may be funded from birth until the year in which the child turns 17, considered the “growth phase.” No withdrawals are allowed during the growth phase. Thereafter, the account becomes the property of the beneficiary and is largely subject to traditional IRA distribution rules.
Funding during the growth period falls broadly into three categories.
Parents, grandparents or pretty much any other individuals, including the beneficiary (the child), may add to the account up to the annual limit of $5,000 per child. Those contributions are after-tax and are not deductible by the donor, like Roth contributions. In addition, employers may contribute up to $2,500 per employee each year for their children, but those are treated differently. Company funds are deductible to the employer and are considered pre-tax to the beneficiary, more like a traditional IRA account. Employer contributions count against the $5,000 annual limit.
Funds may also be added by charitable organizations. Those deposits are not subject to the annual limit and are considered pre-tax. For instance, Michael and Susan Dell announced that their foundation plans to award $250 each to the first 25 million accounts opened.
The twist here is the $1,000 seed money from the U.S. Treasury (taxpayers).
For children born from 2025 through 2028, parents can claim the one-time bonus if the child is a U.S. citizen with a Social Security number. The idea of a government-funded savings incentive emerged from economic research on income inequality dating to the 1990s and has found support from behavioral researchers.
Economists have documented a positive correlation between asset ownership and longer-term planning, including retirement savings. Tedious self-eponymy notwithstanding, Trump accounts could serve as a useful test case for strengthening longer-term retirement security.
Once the child reaches age 18, the rules regarding how distributions will be taxed are complicated, and a fair amount of confusion remains. Taxation of withdrawals depends upon the type of contribution and is best explained by illustration.
Suppose you recently welcomed a bouncing 8-pound addition to the family and immediately established a Trump account for him. Sometime after July 4, the government deposits $1,000 into the account. Off to the races.
Further suppose that you and other family members contribute a total of $30,000 during the growth phase, and one of your employers adds $500 per year until the year in which your son turns 17.
Now, assume that when Junior turns 18, the account has grown to $90,000, and he wishes to withdraw $20,000 for college tuition, an allowable exception to the early withdrawal rules.
Here is where the taxes get complicated.
The $30,000 contributed after tax by individuals is treated as “basis” for tax purposes and distributed tax free. However, he must withdraw pre- and after-tax funds from the account pro rata. Since only one-third of the account balance consists of after-tax contributions, he must pay income tax on two-thirds of the distribution. Clearly in this instance, a 529 account with its tax free distributions would be a superior option.
As with traditional IRAs, any nonqualified withdrawals prior to age 59 ½ are also subject to a 10% excise tax.
A more interesting option in this example would be to convert the account to a Roth IRA at age 18. That would entail reporting $60,000 in taxable income (the taxable part of the account balance) but would eliminate all federal tax liability after age 59 ½.
At a compound annual return of 8%, his balance could reach $3.3 million by the time he reaches age 65, all tax free. Compounding is magical.
This option is obviously most compelling as a generational asset transfer tool for wealthier families who have already provided for college savings and can maximize the annual contribution to the Trump account.
Most families are likely better off opening a Trump account, taking the free $1,000 and then focusing on other avenues like 529 plans or custodial accounts that address more urgent financial priorities during their child’s early adulthood.
There are also a few legal quirks.
Trump accounts may only be opened by a parent or legal guardian. This means that although they may contribute, a grandparent cannot open an account unless they are responsible for the child’s support. A mistake here could be significant since the account form includes a representation under penalty of perjury that the person opening the account may legally do so.
Also note that there is a disparity among various states as to how the account earnings will be taxed. And unlike with 529 accounts, contributions to Trump accounts do not qualify for the annual gift tax exemption. That means parents or grandparents who contribute likely must file IRS form 709 regardless of the amount, even though most will not ultimately owe gift taxes.
The key to understanding Trump accounts is recognizing that they are intended as retirement savings vehicles over very long time frames and as a behavioral tool to help educate younger savers and motivate development of investing habits early. Given the crisis in retirement savings in the U.S., a successful pilot could provide evidence for a meaningful expansion in the future.
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Christopher A. Hopkins, CFA, is a cofounder of Apogee Wealth Partners in Chattanooga.