Trump Accounts Are Live, But Are They the Best Choice?

Speaker A: Trump accounts are live, but are they the best accounts for your kids? You're listening to the Saturday personal finance edition of, uh, the Motley Fool Hidden Gems investing podcast. One of the best things you could do for the youngsters in your life is to set them on the road to saving. After all, time can be an investor's best ally. And no one has more time ahead of them than kids. If you'd like to help your child, grandchild, or just other young person get started investing, you have a few options when it comes to the type of account to open, including a new option. Trump accounts. It's been possible to open a Trump account now for a few months, but as of July 4, they could now also be funded. Here to join me to discuss the details, pros and cons of Trump accounts is my foolish colleague, Joel o', Leary, prolific personal finance writer over at Motley Fool Money. Joel, thank you for joining us. Thank you for having me, Robert. So let's start by giving just like maybe a 30,000 foot view of Trump accounts. What are the main details that people need to know about them? Sure.

Speaker B: Um, the way I think about Trump accounts, um, is they're basically an ira, but for kids. So like a retirement account, but for kids. Um, and you normally need earned income before you can contribute to a retirement account. Uh, but in this case, parents, uh, grandparents, friends, family, uh, or even your employer or government organizations can, uh, contribute to a kid investment account. This is basically what it is. Uh, just like you mentioned, they're brand new. Uh, this was originally created as part of the one big, beautiful, wonderful, amazing Bill Act. And, um, they officially launched on July 4th. So you can open an account, you can fund an account, um, like an ira, it's got some rules. So the maximum you can contribute is $5,000 per kid per year. And the idea is that that money sits and grows. Tax deferred until the kid turns 18 and then it turns into a regular IRA. You're basically kickstarting their retirement. So, uh, yeah, that's basically what the new Trump accounts are.

Speaker A: I'll just add that the idea for these accounts, um, have actually been around for more than 15 years, though the terms have changed. They originally as baby bonds, um, and then American Opportunity accounts. I was actually part of a couple of discussions on, uh, how these should be invested years ago. So I'm happy to see that these accounts are now available nationwide. Um, though, you know, we'll get into the details. They may not be the best account for your kid, depending on the goal for the Money. Um, but let's start with what Trump accounts have going for them. What do you see as the main benefits?

Speaker B: Uh, well, we'll start with the headline feature, which is what I think everyone's anxious to know is, um, is there any free money out there for me? And so with the launch of these accounts, there is. Uh, the government is giving out $1,000 for each baby born, uh, that meets a certain criteria. Uh, and free money doesn't come all that often in personal finance. So if your kid is eligible, this you, you want to jump on it. So here's the criteria. Your baby must be born between, like in the years of 2025, 26, 2027 or 2028. Those four years, your kid has to be a US citizen and they have to have a valid Social Security number. And that's pretty much it. You've got to fill out a form to get started. You've got to open the account and actually claim the thousand dollars. But it's pretty easy. You can download an app, it's Trump Accounts App on your cell phone, and you can set the whole thing up from there. So that $3,000 is, ah, is, is the main reason a lot of people are jumping on it right now.

Speaker A: So once the money gets in there, what happens? You've talked about it that it's like an ira, so you get tax deferred growth. Right. But it's not tax deductible. Correct?

Speaker B: Correct. So, um, I will say, people say tax advantaged accounts.

Speaker A: Sweet.

Speaker B: Sounds like I don't have to pay taxes. Well, that's not really true. Um, like other kiddie investment accounts, um, the money that you put in isn't tax deductible. So parents, you're not going to get tax deduction. If you gift your kid some money, however, the money will grow tax deferred. So just like a traditional ira, all the money in the account can grow. You can change investments, you can make changes, you can even change brokers in a traditional ira, and you won't be taxed on any of those changes. You will, however, be taxed as ordinary income. When you pull out money or pull out those gains, the original contributions are post tax. So ideally, you'll never pay tax on those contributions when you pull them out. But the gains is really, um, the big part because, um, for an account that sits there for decades, it's probably going to be mostly gains by the end of it.

Speaker A: Right? So as we read about Trump accounts, you start to see more evolving strategies, um, things that people recommend and what to do with them. And one of them has been to actually convert these accounts to Roth accounts at age 18.

Speaker B: Yeah, pretty genius strategy actually. Um, because I wish I started my Roth IRA earlier. And wouldn't, um, it be cool if a vehicle was, was opened when you were born that you can convert to a Roth IRA early. So, yeah, I think actually that's probably one of the most powerful, uh, advantages. This is a brand new account, so the strategies haven't emerged like you said, or these particular use cases. But if I wanted to think about my kid, when they turn 18, if they have a Trump account that has, let's say, you know, let's say it's grown to like 20, 30 grand, which is realistic. Um, they can, when they turn 18 and within the first few, you know, years, whether they're at college or they have a, have a job, they can make Roth conversions in small amount or, or a big Roth conversion and then that money sits and it can grow tax free for the next 40 years until retirement instead of tax deferred. Um, Roth IRAs are very flexible when it comes to withdrawals and things like that. So yeah, absolutely. I think that's a, that's a really powerful advantage.

Speaker A: Yeah. And as you read about this strategy, you'll come across, uh, the pros and cons of it. First of all, you know, most people in their late teens or early 20s are in low tax brackets. The conversion can be taxable, but ideally they're not paying a whole lot. That said, um, up until age 24, some kids will be subject to the kiddie tax. It's a little complicated, but that means some of that conversion might be taxed at the parents tax bracket. And there's some question about how these conversions might affect financial aid eligibility in college. So like everything related to taxes, make sure you do your research before doing it. Um, and then let's get to one other benefit, uh, of Trump accounts. Or at least in your mind and in mine as my mind as well, in terms of the investment choices within the account.

Speaker B: Yeah, sure. So the accounts are designed so that uh, all the money inside is invested in broad low cost domestic index funds. And um, this is a strategy that I love personally for the average investor. And um, the thing that I like about it is, um, when you give people limited options, it means that it's really difficult to screw up. And um, so a couple of cool things. First of all, there's no monthly account fees, there's no brokers you can choose from. You've only got one option you're not going to get swindled, um, by advisors or um, people that can take fees for not providing value. You're not going to underperform the market because you're. All your investments are invested in the broad market. So um, it really is a, um, a uh, boring investment account which is perfect for most people. You can't day trade in it, you can't make risky silly bets in it. Uh, right now the default fund for all Trump accounts is the State Street SPDR portfolio. It's ah, an S&P 500 index that tracks the S&P 500. The expense ratio is 0.02% which um, is next to nothing. It means if you've got $10,000 in the account, you're only going to pay $2 in fee for the year. Uh, so anyway, I'm a huge fan of it. I think this limited investment menu is a pro. Um, what do you think, Robin?

Speaker A: Yeah, so I'm a big believer in index funds. When my wife and I opened brokerage accounts for our kids, we always started with a, uh, foundation of index funds. So I love this as the beginning. I think what we will see is more choices offered in terms of maybe an international index fund not available yet. In fact, the original law prohibited even cash being in the account. So you have to invest in stocks, ideally with the long term. That'll all work out. Uh, but generally speaking, I love the fact that there's a foundation of index funds here. Um, let's get to one final benefit and then we'll move on to some drawbacks. And you talked about that you, uh, many people will be eligible to get free money from the government. Um, but it's not just the government that's going to be contributing to these. More and more nonprofits and employers are stepping up to possibly make contributions to these accounts.

Speaker B: Yep, that's right. Um, and you've probably seen the news on some philanthropists out there that are, um, donating large amounts of money, um, to spread across uh, certain types of kids, eligible kids, which I think is really cool. Um, but the standard rules are that um, any Trump account can receive up to $2,500 in uh, matching employer contributions or contributions, uh, from like the philanthropists or philanthropic organizations. Um, I think we will see more of this pop up over time. Right now there are some, there are a lot of big companies that have sort of pledged to create some sort of matching program for their kids, um, or, sorry, for their, their employees kids. Uh, I'm certainly interested in it. Whoever's Listening Motley fool wants to, um, add it as part of our employee benefits package. That'd be, that'd be really nice. Uh, any free money we can take, uh, is great.

Speaker A: And, uh, you know, you say that as someone who has kids who are available. Um, so I will just point out that, you know, the eligibility age for this is up to the year that someone is age 17 or younger by the end of that year. So in the year that someone turns 18, you can no longer contribute to a Trump account. And you mentioned the $2,500 limit from employers. Just a little tidbit here is that is per employee. So if an employee has three kids, the employee has to decide, you know, how to split up that 2,500among the three kids. Uh, and that $2,500 does go towards the $5,000 limit, but money from government or nonprofits does not go to that limit. So you can put the 5,000 on top of all that.

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Speaker A: All right, so we just talked about plenty of benefits. What do you see as potential drawbacks of Trump accounts?

Speaker B: Sure, I think, uh, any, um, any retirement account is going to have rules around, um, where it's held, uh, and particularly around withdrawals. So this probably the biggest drawback is the rules and if, um, uh, it could come back and bite you depending on your situation. So basically, here are the withdrawal rules, um, for the first 18 years or until the child turns 18, no withdrawals are allowed. The money's designed to stay in there. Uh, it's a one way street. So this is um, like again, this could be cool for some people that want to lock up funds and not have early withdrawals. Uh, however, it might be a bummer for families that have other goals that pop up, um, that they want to spend the money for the benefit of the kid. For example, like, um, spending, paying for A K through 12 education, you know, education supplies, maybe helping the kid buy a car or if they want to move and do a semester abroad. Those are some examples I can think of that maybe you want access to those funds before the age 18 in a Trump account. You can't.

Speaker A: All right, so then the kid turns 18 and at that point, by the way, they have control over it. Then what happens?

Speaker B: Yeah, they have control over it like a traditional ira. So it's uh, so yes, they have control, but it's not just like, here's the money, it's um, here's an account. And so that account rules then follows traditional IRA rules. So if you want to pull out money from there, standard withdrawals, you can pull it out for whatever reason, but you're going to pay a 10% penalty on any funds you pull out. If you're under the age 59 and a half. Just like a traditional IRA, there, uh, are some penalty free use cases. So uh, for example, using the money for higher, uh, education, or you can withdraw, uh, money for buying a first down payment on a home up to a certain limit. I think it's $10,000. Uh, that may change. Ah, so there are some qualified withdrawals, but for the most part the account is designed that you will leave the money until the k, until a person is 59 and a half. So it is, it is truly a retirement account.

Speaker A: Yes. And everything you said is correct. And it is related to federal taxes. I will point out that, um, you should check with your state because not all states are conforming their laws to the federal laws. And this is another area that is evolving. So just uh, check in to see how your state is going to tax these. Um, and as we mentioned previously, contributions from parents, grandparents or adults that comes in after tax, which can be a little challenging because you want to track that so that you make sure that it comes out tax free when you take out the withdrawal.

Speaker B: Yeah, that's another, um, downside and um, sort of. It remains to be seen how difficult that would be. But I like to think of it as, um, right now adults can put after tax contributions into their 401k, but it really messes the account because then you've got a mix of pre tax and post tax funds in there. And so when it comes time to withdraw, which section are you withdrawing and what taxes do you pay on what? So I do think that, um, mingling pre tax and prosec funds can, uh, be a headache. So strong record keeping is required. How much money you're putting in, make sure it's all tracked. Uh, that's, that's certainly a drawback because even as someone who's a finance nerd like me, that's a tough job and

Speaker A: you might be tracking it literally for decades. So it can be a challenge. And again, a lot of the guidance here is evolving, but from what I can tell from the tax pros that I've read from, that you should be filing Form 8606 every time you make one of these after tax contributions to a, uh, Trump account. It's the same form you'd use if you make after tax contributions to a traditional ira. Just talk to your tax professional about doing that. Um, we've talked a little bit about the annual contribution limits. Talk about how that's somewhat of a downside.

Speaker B: Yeah, I don't think, I mean, all, um, I wish I could stuff more money into my Roth ira. Um, you know, they have limits for a reason because, um, if they don't, uh, you know, people that can gift large sums can, can move money around and take advantage. So for all you, like mega rich people out there trying to drop 50k into their kids, uh, Trump account, that you can't do that. Um, so the $5,000 max per year per kid, um, I will say that this account is basically designed so that you can slowly contribute to your kid and grow a retirement account over time. It's not for large gifts or inheritance or things like that. So that could be a drawback for people that really do want to, you know, pass, uh, on their wealth. This is not an account for doing massive amounts like that.

Speaker A: And I'll just add that I believe in 2028 the account limits will start to be adjusted for inflation. But it won't be a huge, you know, be a little step up a little bit each and every year. And we talked a little bit too about how at age 18, it becomes their account. So there's a certain amount of loss of control. You, you assume they'll be responsible because you've taught them all along the way how to be a responsible person with the money but there are no guarantees. Right? So that's one of the benefits of an account like, oh, you know, maybe a 529, where you always maintain control of the money. So I just want to highlight that as another potential downside.

Speaker B: Yeah, you know, Rona, actually, let's dive into that because I was just thinking the other day, um, people already are raiding their own 401ks and IRAs, their retirement accounts, and this is money that they have personally saved and suffered to save, and they're going and raiding that. So imagine having money that you haven't personally saved that is literally gifted to you. Um, you're almost certainly going to raid that account for the same reasons. And if you think about the penalty, which is 10%, if we think of the flip side, it's only 10%. So a kid who's 18 that got a $3,000 when they were a baby, they turn 18, and even if they don't touch the account or put any other contributions when they turn 18, it's probably got like five grand in it. And the kid is thinking, um, it's only a 10% penalty to pull that fund. That's only 500 bucks. And then I'll get 4,500. So, um, yeah, I really do think that pairing, uh, whatever you're gifting your kids, pairing it with education is so important. Um, it's more important. It's a must have. So, um, yeah, I do think, uh, turning over control to your kids at 18 is, is a scary compromise.

Speaker A: Yep. Yep. I think the stats are from Fidelity that something like 40% of people, when they switch jobs, they cash out their 401k rather than transfer, transferring it to an IRA. So just to support your point, there are a lot of people raiding their accounts probably sooner than they should.

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Speaker A: All right, Joel, give us your final verdict. Who should consider Trump accounts and who should perhaps consider another type of account?

Speaker B: Uh, first and foremost, anyone who can get any type of free money, go and claim that. And um, you've got a little while you can open an account and, and claim it for your kid later, but claim it now because the earlier you can invest that money, that $3,000, uh, the longer it has to grow. Um, it's pretty easy for anyone that does have a baby born and is eligible and uh, within that four year stretch, just head over to Trump. You can download the mobile app from there, fill out the forms. It's super easy, get going. I don't see any downside to getting the free money. Um, the next thought is, well, what about if my kid's not eligible? Is this still a good account? And um, while yes it is, I would say that, um, if you already have a plan, uh, for your kids to start them off investing, if you already have investment accounts for your kids, um, my feeling is to just keep doing what you're doing. I personally don't see Trump accounts having a, a massive enough benefit to switch strategies on whatever you're doing. If you've got a 529, they're perfect for college. And even if education doesn't work out for them, there are other flexible alternatives to, to use that money or exit options. Um, if you've got a working teen, uh, Roth IRA is just get started with that. A custodial Roth ira. They need earned income but you know, you avoid everything like taxes going forward is pretty amazing. Uh, personally my kids don't qualify for the thousand dollars, uh, free seed money. Um, I will open up an account if it becomes a work benefit, uh, for me that's uh, again that's Matched, um, money is, is good for me. Um, I have custodial brokerage accounts for my kids. Personally, I love custodial breakage accounts just because there's really no big restrictions. Uh, I can put in whatever contributions I want. There's no limit. I've got full control of investment options. I can switch brokers, I can avoid fees. Uh, I'm a nerd, so I love that stuff. And then when the kid turns 18 or when my boys turn 18, I'm going to hand this account over them and they can do whatever they want with it. Um, I am, I mean I don't want to get into the weeds, but doing some small, uh, amounts of tax gain harvesting within their accounts so the tax burden will hopefully will be less later. Um, so that's an option for me. Um, and obviously my plan is to teach my kids about money so that when they do have access to the account, they're not going to just go blow it off. So, um, yeah, those are the other options that I'd consider. There will, I do say that if you can see a path to doing rush conversions for your kid, that's probably like we discussed, a very powerful strategy. Um, and uh, so a Trump account might make sense for you if you don't have any other vehicle for them. Ah, I will say that, um, it could be a good place to accept family contributions. And this is a situation I've come across. An auntie will come in and say, hey, I want to give money to your kid. Um, but I don't want them to spend it. I don't want them to have access on their 18. I don't want them to spend it right away. I want this to be for their retirement. I don't want it to be tied to a goal of getting a car, a house or whatever. Like, I literally struggle with retirement. I want them to know, not struggle so here.

Speaker A: So, uh, a Trump account could, could

Speaker B: be cool for just accepting, you know, family gifts and um. Yeah. So whether it makes sense. It really depends on your situation. I think more use cases will come out over time. Uh, but that's, that's my two cents. I'm curious to hear yours though, bro.

Speaker A: Uh, well, I agree with a lot of what you said and I love that you're doing tax gain harvesting. It's not talked enough. Uh, I think it's a way basically if you're at a certain low income level, your long term capital gains are tax free, you have to, you have to manage it properly. But I love that you're doing that.

Speaker B: Also, the kiddie tax is, um, there is a kitty tax, there is a free band of kiddie tax. It's small amount, but, um, you can go ahead and um, long term capital gains, $0. So, um, again, it's small amount, so we're not messing with massive, you know, tax avoidance here. But, um, yeah, if you're smart and you do it every single year while the kid is young, uh, it can have a bigger impact later on. So that's my way to, um, sort of make sense of not putting, not opening a 529, um, or going the Trump gap route.

Speaker A: Yeah. Since we're reaching the end here, I want to clarify some confusion. There has been out there about the websites related to these accounts. So the best source of government information is TRUMP accounts, plural.com. now if you want the web version of opening the app, it's trumpaccount.com so singular. Now there are many sites that are coming up that are just providing education and information, such as trumpaccounts.com so that is not affiliated with the government. So don't go there if you want to open your account. But it is run by the same folks who do savingforcollege.com, which is a great resource. So I'm going to presume they're going to do some solid education about Trump accounts there. But just understand which site to go to when you want more information. Um, and I'll echo your recommendation that a 529, if your goal for the money is purely education, a 529 is the best way to do that because not only you have more investment options, but the distributions are tax free. Um, and as you kind of hinted at, if you don't use the money, there are other options, such as rolling it over to a Roth ira. Um, there are some requirements about that, but it can be done. Um, and since this is a Motley fool audience, we know that there are people out there who are stock pickers. They like investing in individual stocks. If you really want to teach your kid about that, then the Trump account is not the one for you. A regular custodial brokerage account may be the way to do it, especially if you want them to use the money before retirement. But as a head start for starting for saving for retirement, a Trump account is definitely worth considering. You think of opening this up for a kid who's, you know, 5, 6, 7, even 15, 16, and letting that grow for decades, it's going to be a huge amount of money.

Speaker B: Actually, I will Say that, um, opening an account for someone is pretty cool. I think back to when I was in, uh, my early 20s. I got my first job, and, um, all my, uh, mentors and colleagues were like, hey, young kid, you should start saving for retirement. And it was kind of stressful, you know, I know I needed to, but it was also like, you know what? Can I just do it later? What are these accounts? 401k? I don't even know. So, um, just opening the account was a difficult first step, and it still is for many people out there who don't know anything about investing. But imagine if an account was open for you, and even if there was only a few hundred dollars in it, it doesn't matter. Um, or a thousand dollars that's grown over time. You see this account, it's already got your name on it. It's already a vehicle. So the hardest part is removed. Think that, um, don't focus on giving your kid tens of thousands of, whatever, dollars. Just remove the barrier to that first step, which is opening an account and transitions to a regular ira. So, um, yeah, I do think, uh, it is a good account.

Speaker A: Well, Joel, this has been a great conversation. Thank you so much for joining us.

Speaker B: Thank you very much for having me. Cheers.

Speaker A: And that, my foolish friends, is the show. Thanks for listening. And thanks as always, to Bart Shannon, the engineer for this episode. People on the program may have interest in the investments they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell enticements based solely on what you hear. All personal finance content follows Motley fool editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. I'm, um, Robert Brokamp. Full on, everybody.

Speaker B: Sam.