How to educate your children about custodial accounts and Trump Acccounts
Last week, my fiance got an unusual text from his parents: “What’s your Social Security number?”
Once he confirmed he wasn’t being scammed, he sent it along and got a bit of good news. His grandparents had opened an investment account for him shortly after he was born, and he was now the proud owner of a portfolio of Coca-Cola stock.
Well, the account had technically become his on his 18th birthday — he’s 30 now. So why had his parents waited all this time to let him know about this? Truthfully, they’d forgotten about it, his mother told him over the phone. Plus, she added, you didn’t have Ryan to help you plan how to use it.
It was a fair point. As soon as I heard the news, I’d begun calculating the capital gains tax my fiance could owe if he sold the stock to bolster our wedding fund. The 18-year-old version of me probably would have started looking up prices on used sports cars. Which got me thinking about a group of people that The New York Times recently called the “new investor class“: children.
Thanks to the rollout of Trump Accounts authorized in last year’s One Big Beautiful Bill Act, a generation of kids will be coming of age with investment accounts that they control. And unlike my fiancé, they won’t have a financial writer doing the dishes in the other room when they get the news.
That’s why you’d be wise to talk early and often with children about the money you’re investing on their behalf, including how to manage it and what it’s for, says Megan McCoy, a financial therapist and professor at Kansas State University.
“If the intention is, I’m trying to scaffold your future and give you less financial stress and help you reach your financial goals, there has to be discussion so that it doesn’t just feel like found money,” she says.
How custodial and Trump Accounts work
Traditionally, if you were looking to open an investment account on your child’s behalf, you’d open a custodial account, such as a UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfers to Minors Act). There are some slight differences between the two account types, but the general rules are the same: The account legally belongs to the child and comes under their control when they reach an age between 18 and 25, depending on the state.
Once they gain control of a UGMA or UTMA account, the child can use the funds for any purpose, which distinguishes the accounts from more specialized vehicles, such as so-called 529 accounts for education savings. And like brokerage accounts, realized earnings are taxable, meaning that the child will owe capital gains tax if they sell an investment for more than you paid for it.
Any money your child stands to receive via their Trump Account comes with a few more strings attached. As with a custodial account, an adult can fund a Trump Account on a child’s behalf, up to $5,000 per child per year. Once the child turns 18, they take control of what is essentially a traditional IRA. With exceptions, including those for education and some home-buying expenses, money taken out before age 59½ is subject to income tax plus a 10% early withdrawal penalty.
But even with those restrictions in place, it’s not hard to imagine a young adult taking the money out and spending it absent certain money conversations, says Jon Lapp, a certified financial planner with Haven Financial Advisors.
“You are going to run into those situations where there are absolutely a lot of 18-year-olds out there that are not going to be equipped to handle a lump sum of money,” he says, and that could result in some poor outcomes for the child. At best, financial experts say, a child unequipped to handle the money could end up spending it frivolously instead of putting it to financial goals. At worst, they could wind up with a tax bill having already spent the money they had to pay it.
When communicating financial goals pays off
To avoid such scenarios, it’s important to educate your children about money early and often — and that starts with a baseline of good financial hygiene, says Lapp.
“It’s going to be a sliding scale with age, but it’s those basic principles. Spend less than you make, put some of the excess away, invest it in something useful that’s actually working for you and growing for you,” he says. “Those basics are absolutely the most important thing.”
From there, if you are putting money into investments on their behalf, it’s important to explain a few nuts-and-bolts lessons to your kids about the accounts they stand to inherit. One is the tax implications of the account they hold. If you invested in assets that have appreciated over time in a custodial account, your kid will owe capital gains tax if they sell the investments. If your child plans to cash out of a Trump account early for a non-educational or home-buying expense, it’s important to know what kind of penalty they might owe in addition to their income tax bill.
Should your child reach young adulthood and face a particularly complicated tax situation related to one of these accounts, you may even want them to consult a financial professional, says McCoy.
You’d also be wise to explain the power of compound interest, financial experts say. Researchers at Morningstar project that the mean Trump Account-holder receiving $1,000 annual contributions from birth would have more than $50,000 in their account by age 18. While that’s a tempting amount of money to spend, it’s worth noting that the same investor who makes no additional contributions to their account as an adult could have $850,000 by age 55, according to Morningstar’s estimates.
It’s a concept that’s important to tie in with talks with your child about their short- and long-term goals, says McCoy.
“What’s the power of delaying gratification so that you can use that money for bigger goals in the future?” she says. “It’s not having one conversation. I think it’s having lots of conversations about your dreams and hopes for the future.”
Overall, it’s important to be as clear as you can with your child about the intentions behind the money you’re investing on their behalf, McCoy says. Maybe you’re hoping to kickstart their retirement or get them started on the road toward buying their first home. Talking through these ideas will help them make the best use of the money when it comes under their control, she says.
“It’s not saying, ‘This is a goal you have to pursue,’ but helping them verbalize what they want for their future and how you can help them get there.”
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