Trump Accounts vs. 529: Assessing the Pros and Cons

Key Takeaways

• The new “Trump accounts” can be used for educational purposes, but they are retirement-focused and function more like long-term retirement savings vehicles.
• A Trump account starts with an initial $1,000 government contribution. Anyone may contribute to the account.
• From a tax standpoint, a Trump account works like an IRA, with some exceptions.
• Choosing between the two accounts depends on your goals. If your priority is education, a 529 may be a better choice. Trump accounts may be used to encourage long-term retirement savings.

Christine Benz: Hi, I’m Christine Benz for Morningstar. People with young children will be able to set up what are being called Trump accounts starting at midyear. For many families, that raises the question of whether they’re better off contributing to a Trump account or saving in a 529 college savings plan.

Joining me to discuss that topic is Tim Steffen. He’s the director of advanced planning at Baird. Tim, thank you so much for being here.

Tim Steffen: Thanks for having me, Christine.

What Are Trump Accounts Designed For?

Benz: Well, it’s great to have you here. I want to start with some stage-setting, especially because the Trump accounts are pretty new and less familiar than 529s. These accounts aren’t explicitly for college savings, correct?

Steffen: No, in fact, they’re not. They’re really much more of a retirement account. Early versions of these allowed for some distributions that provide some tax preferences if you use them for education, but that all fell out of the final version of the bill. These are really meant to be retirement-specific accounts now.

Benz: I want to discuss that dimension in a second, but people may have heard about the $1,000 initial government contribution that’s going into the Trump accounts, and that’ll be for children born between 2025 and 2028. But parents and other family members can contribute, as can employers, in the years leading up to the child’s 18th birthday, and the child doesn’t have to have been born within that window. Can you discuss the tax treatments of those various types of contributions?

Who Can Contribute to a Trump Account?

Steffen: Right. There are basically four different ways you can get money into one of these accounts. You talk about the initial $1,000 government contribution from anybody born ’25 through ’28. That goes into it. It’s not a taxable event for the recipient. It’s just a gift into the account that comes from the government itself. Then, anyone else can put money into one of these accounts. The maximum that can go in, in any calendar year, is $5,000. It can come from anybody: parents, grandparents, siblings, whoever wants to put it in there. But the total is limited to 5,000. Those are nondeductible contributions. They’re effectively gifts into the account from the donor. Employers are also able to put some money in there on behalf of an employee or even a child of an employee. Those are limited to $2,500 per employee. If an employee has multiple kids, they’d have to spread it around.

That is not considered income to the participant, or to the employee, either. So, it goes into the account. It’s a nontaxable event for the recipient. The last one is contributions that come from typically charitable organizations. We’re seeing some private foundations that are willing to make some grants into these. Again, those are also not going to be income. With all the contributions, there’s no income recognized by the recipient, but there’s also no deductions claimed by the donor in any of these cases, either.

How Do Taxes Work in a Trump Account?

Benz: OK, Tim, that’s helpful. You mentioned these are primarily meant to be retirement accounts, and the accounts do convert to a traditional IRA once the child reaches age 18. Say the child decides to liquidate the account to pay for college, which many students, many people are doing at that life stage. What taxes would be due if that were the decision with those Trump account assets? What would the tax treatment be if he or she didn’t use the funds for college but wanted to pull them out at age 18?

Steffen: At age 18, these accounts effectively become IRAs. They technically don’t become IRAs. They’re still a Trump account, although you can roll it to an IRA if you choose to do so. From a tax standpoint, it works just like an IRA does. Once you turn 18, any distributions out of that, other than ones that are considered a return of your basis—basis comes from certain contributions—any growth in the account when it comes out, it’s going to be fully taxable. If you are under 59½, and presumably somebody using it for college would be under 59½, that’s also going to be subject to a 10% penalty, but then there’s exceptions that apply to that. Any distribution beginning 18 or forward is going to be taxable and penalized unless you meet one of the exceptions. Using it for education costs is one of the exceptions to that penalty, so it works a little bit like a 529, but not exactly.

Benz: OK. How about the person who uses this account, as it sounds like it was intended, where they hang onto the account until they’re, say, age 59½. What’s the tax treatment in that instance?

Steffen: Then it’s just like it was a traditional IRA. Again, it can be rolled to an IRA, which it literally is an IRA then. Or it can just leave it in a Trump account, and all the tax treatment of an IRA applies to that as well. So, 59½, you take it out, pro rata rule applies. Pro rata withdrawal of basis and earnings. Once you hit the certain age, like 75 for these kids who are going to be having the accounts, they’re subject to required minimum distributions. They would be required to take money out at that age. That’s a long time from now. We’re talking 60-plus years before we have to worry about any of that, but it’s going to happen.

Converting Your Trump Account to a Roth

Benz: OK. Would converting the account to a Roth after age 18 be a possibility? It seems like it could be attractive, especially if the account owner, the young person, is in a fairly low tax bracket at that time.

Steffen: You’re right, converting it to a Roth is an attractive option, especially when you consider most of the contributions create basis in there and wouldn’t be taxable upon conversion. Just the growth would be taxable. Your point about tax rates is the key one because most 18-year-olds, if they’re going to school still, are going to be subject to the “kiddie tax,” which means this conversion would be taxed at the parents’ tax rate after a certain small exemption amount. There’s a little bit that would be exempt from that. Anything larger would be taxed to the parents. While a Roth conversion would be appropriate, you might want to wait until the child is exempt from the “kiddie tax,” meaning they’re either 24 years old or they’re out of college, out of school, and they’re on their own. They become their own taxpayer. Then, the conversion might make a little bit more sense, but absolutely, a Roth conversion is kind of the next phase of what should happen with these Trump accounts down the road.

How Are Trump Accounts Different From 529s?

Benz: I want to switch gears and talk about 529s, and contrast these Trump accounts with 529s. 529s, of course, are explicitly for education savings, not necessarily college savings, but in contrast with the Trump accounts, there’s no free government money going into a 529, right? But I would receive a tax break, potentially, depending on my state.

Steffen: Correct. There’s no explicit government contribution to these, like with the Trump accounts. There’s no federal tax deduction with a 529, like there might be with others, but not with Trump accounts. From that standpoint, they’re the same. On the state side, yes. Many states offer a deduction for contributing to a 529. State tax rates tend to be, compared with federal rates, much lower. So, is the tax benefit that significant? It’s usually not a huge issue, but it’s something. If you’re eligible for it, you obviously want to take it. Will states ultimately allow deductions for Trump accounts? Seems unlikely, but you never know; it could possibly happen, but there’s no talk of that happening right now. The big difference between the two would be how much you can put into the 529. The Trump account’s going to be a much smaller dollar level. 529s are, and they’re not quite unlimited, but they’re pretty close.

Benz: Based on what you’ve just said, 529 accounts look pretty favorable from the standpoint of withdrawals for college savings. Can you discuss that?

Steffen: Yeah. 529s, if the withdrawal is for a qualified education expense, it comes out completely tax and penalty-free. You don’t get that option with a Trump account. There’s always going to be some tax liability associated with that. If the intent is to use these funds for education, the 529 has a pretty clear advantage over the Trump account. Trump accounts have other advantages, but from an education standpoint, a 529 is still going to be clearly your better option.

Using Your 529 Outside of Educational Expenses

Benz: OK. What happens if someone doesn’t use the 529 for qualified education savings? It seems like the 529 is a lot less flexible than the Trump account if their use case is different from education.

Steffen: It can be. A few years ago, they created this ability to roll portions of a 529 to a Roth IRA. That would be an option for somebody. You can always transfer that to another family member, to a sibling, to the next generation if you want. Trump accounts, you can’t transfer. That’s yours, because it’s like an IRA; you can’t gift that to somebody else. Whereas 529s, again, if you’re not going to use it for education and you don’t need the funds, you can always give it to somebody else and let that continue to grow on a tax-free basis, and let somebody else use it for education. Again, for education, 529s are way ahead of everything else.

Points to Consider

Benz: What guidance can you offer to parents or family members who have a fixed amount that they can put toward a child’s well-being, whether it’s education or something else? What guidance would you have for them in terms of deciding which accounts to put their dollars into?

Steffen: It really comes down to: What are you trying to incentivize out of the child when you give them money? What activity are you trying to steer them toward? If it’s going to education, it’s going to college or even a private high school—or a grade school, if you want—you can use 529s for that. The 529 has a definite advantage in those cases. If you’re trying to establish an idea or a sense of funding for retirement, which is maybe hard to understand for a young child, a newborn, why am I putting money away for retirement? If you want to try to instill a sense of retirement focus, the Trump account will be your advantage there because you really can’t go from a 529 to a retirement account. That’s not allowed. I think again, most times, most people are thinking for young kids, the focus is education, but if you’d like to maybe diversify their savings a little bit and allow somebody to go into a retirement account, I think the Trump account is the way to go.

Benz: Well, Tim, we always love talking to you. Thank you so much for being here.

Steffen: Thanks for having me, Christine.

Benz: I’m Christine Benz from Morningstar. Thanks for tuning in.

Watch How to Build a Core Portfolio You Can Add Stocks To Over Time for more from Christine Benz.