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

0:02Trump accounts are live, but are they the best accounts for your kids? You're listening to the Saturday Personal Finance Edition of the Motley Fool Hidden Gems Investing Podcast.

0:16One 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 4th, 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.

0:52Joel, 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 um the way I think about Trump accounts um is they're 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. But in this case, parents, grandparents, friends, family, or even your employer or government organizations can contribute to a kid investment account. This is basically what it is.

1:34Just like you mentioned, they're brand new. This was originally created as part of the one big, beautiful, wonderful, amazing bill act. And they officially launched on July 4th. So you You can open an account. You can fund an account. 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 yeah, that's basically what the new Trump accounts are. I'll just add that the idea for these accounts have actually been around for more than 15 years, though the terms have changed.

2:20They were originally proposed as baby bonds and then American opportunity accounts. I was actually part of a couple of discussions on how these should be invested years ago. So I'm happy to see that these accounts are now available nationwide. 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. But let's start with what Trump accounts have going for them. What do you see as the main benefits? Well, we'll start with the headline feature, which is what I think everyone's anxious to know is, is there any free money out there for me?

2:54And so with the launch of these accounts, the government is giving out$1 ,000 for each baby born that meets a certain criteria. And free money doesn't come all that often in personal finance. So if your kid is eligible, you want to jump on it. So here's the criteria. Your baby must be born between like in the years of 2025, 26, 27, or 2028. Those four years. Your kid has to be a US citizen and has 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$1 ,000. But it's pretty easy. You can download an app.

3:35It's Trump Accounts app on your cell phone, and you can set the whole thing up from there. So that$3 ,000 is the main reason a lot of people are jumping on it right now. 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? Correct. So I will say, people say tax advantaged accounts. Sweet, sounds like I don't have to pay taxes. Well, that's not really true. Like other kiddie investment accounts, 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.

4:22However, 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 the big part because for an account that sits there for decades, it's probably going to be mostly gains by the end of it.

4:57Right. So as we read about Trump accounts, you start to see more evolving strategies, 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. Yeah, pretty genius strategy, actually, because I wish I started my Roth IRA earlier. And wouldn't it be cool if a vehicle 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 advantages. This is a brand new account, so the strategies haven't emerged, like you said, or these particular use cases.

5:39But 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 yeah and as you read about this strategy, you'll come across the pros and cons of it.

6:24First 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, 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. And then let's get to one other benefit of Trump accounts, or at least in your mind and mine as well, in terms of the investment choices within the account.

7:03Yeah, sure. So the accounts are designed so that all the money inside is invested in broad, low-cost domestic index funds and this is a strategy that I love personally for the average investor and the thing that I like about it is when you give people limited options it means that it's really difficult to screw up and 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 you're not going to get um swindled by advisors or 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 boring investment account which is perfect for most people but you can't day trade in it you can't make risky spilly bets in it uh right now the default fund for all trump accounts is the state street spdr portfolio it's an s &p 500 index that tracks the s &p 500 the expense ratio is 0.02 percent which um is is next to nothing it means if you've got ten thousand dollars in the account you're only going to pay two dollars in fee for the year uh so anyway i'm a huge fan of it i think this limited investment menu is a pro.

8:29What do you think, Robin? Yeah, so I'm a big believer in index funds. You know, when my wife and I opened brokerage accounts for our kids, we always started with a 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. But generally speaking, I love the fact that there's a foundation of index funds here. Let's get to one final benefit and then we'll move on to some drawbacks.

9:07And you talked about that many people will be eligible to get free money from the government, 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. Yep, that's right. And you've probably seen the news on some philanthropists out there that are donating large amounts of money to spread across certain types of kids, eligible kids, which I think is really cool. but the standard rules are that any Trump account can receive up to$2 ,500 in matching employer contributions or contributions from like the philanthropists or philanthropic organizations 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 or sorry for their employees' kids.

10:06I'm certainly interested in it. Whoever's listening, the Motley Fool wants to add it as part of our employee benefits package. That'd be really nice. Any free money we can take is great. And you say that as someone who has kids who are available. So I will just point out that 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 how to split up that$2 ,500 among the three kids.

10:54And 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.

11:11Whether you're trying to analyze market or business trends or dig through hundreds of pages of quarterly reports, the sheer volume of data can feel overwhelming. Lately, I've been using Claude's deep research feature as my ultimate thinking partner. I hooked it up to my Google workspace tools and it was able to run a reliable, comprehensive analysis across dozens of different financial sources in minutes, helping me spot long-term connections that on my own, it may have taken me hours or even days to see. Claude is the AI for minds that don't stop at good enough. It's the collaborator that actually understands your entire workflow and thinks with you.

11:46Whether you're debugging code at midnight or strategizing your next business move, Claude extends your thinking to tackle the problems that matter. For problems worth solving, get started with Claude at Claude.ai slash fool. That's Claude.ai slash fool. And check out Claude Pro, which includes access to all of the features mentioned in today's episode. Claude.ai slash fool. All right. So we just talked about plenty of benefits. What do you see as potential drawbacks of trump accounts 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 is probably the biggest drawback is the rules and if um and 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 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 uh for example like um spending paying for a K-12 education, you know, education supplies, maybe helping the kid buy a car, or if they want to move and do a semester abroad.

13:16Those 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. All right. So then the kid turns 18. And at that point, by the way, they have control over it. Then what happens? Yeah, they have control over it like a traditional IRA. So it's 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 their standard withdrawals you can pull it out for whatever reason but you're going to pay a 10 penalty on any funds to pull out if you're under the age 59 and a half just like a traditional ira uh there are some penalty free use cases so for example using the money for higher education or you can withdraw money for buying a first down payment on a home up to a certain limit.

14:10I think it's$10 ,000. That may change. So there are some qualified withdrawals, but for the most part, the account is designed that you will leave the money until the person is 59 and a half. So it is truly a retirement account. Yes, and everything you said is correct and it is related to federal taxes, I will point out that 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 check in to see how your state is going to tax these. 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.

14:58Yeah, that's another downside and sort of it remains to be seen how difficult that would be. But I like to think of it as 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 mingling pre-tax and post-tax funds can be a headache. So strong record keeping is required. How much money you're putting in, make sure it's all tracked. That's certainly a drawback because even as someone who's a finance nerd like me, that's a tough job.

15:42And you might be tracking it literally for decades. 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 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. We've talked a little bit about the annual contribution limits. Talk about how that's somewhat of a downside. Yeah, I don't think, I mean, I wish I could stuff more money into my Roth IRA.

16:18You know, they have limits for a reason because if they don't, you know, people that can gift large sums can move money around and take advantage. So for all you like mega rich people out there trying to drop 50k into their kid's Trump account, you can't do that. So the$5 ,000 max per year per kid, 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 on their wealth. This is not an account for doing massive amounts like that.

17:03And 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 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.

17:34So I just want to highlight that as another potential downside. Yeah, you know, Rota, actually, let's dive into that because I was just thinking the other day, 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. 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 three thousand dollars 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.

18:30So yeah, I really do think that pairing whatever you're gifting your kids, pairing it with education is so important. It's more important. It's a must have. So yeah, I do think turning over control to your kids at 18 is a scary point. 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 transferring it to an IRA. So just to support your point, there are a lot of people rating their accounts probably sooner than they should.

19:09They say leadership isn't just about where you're going. It's about the conviction it takes to get there. For those who demand the world and possess the drive to claim it, there's a vehicle of equal distinction. Dynamic by design and engineered for pure impact, the Range Rover Sport rises to meet you the moment you take the lead. This is the most advanced Range Rover Sport yet, a master class in uncompromised performance and unbridled agility. Inside, the innovation is seamless. You'll find an elegant 13.1-inch touchscreen that puts total control of the vehicle's systems right at your fingertips, but it's the refinement that sets it apart.

19:45Sculpted 22-way heated seating with built-in massage function ensures every journey is defined by peerless comfort. Whether it's through unique interior finishes or custom wheel options, the ways to personalize your Range Rover sport are nearly unlimited. Command attention and experience ultimate luxury in motion. Exclusive offers are available now. Explore further at RangeRover.com. Right now, get up to 15 % off select storage solutions. Put heavy-duty HDX totes to good use, protecting what's important to you. The solid, impact-resistant design prevents cracking, and the clear base and sides make items easy to find even when the totes are stacked.

20:24Find select shelving and tote storage up to 15 % off at the Home Depot to organize every room in your home, from your garage to your attic. Visit homedepot.com, how doers get more done. All right, Joel, give us your final verdict. Who should consider Trump accounts and who should perhaps consider another type of account? first and foremost anyone who can get any type of free money go and claim that and 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 three thousand dollars the longer it has to grow it's pretty easy for anyone that does have a baby born and is eligible and within that four-year stretch just head over to trumpaccounts.gov 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 well 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 my feeling is to just keep doing what you're doing i personally don't see trump counts 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 taxes going forward is pretty amazing.

22:11Personally, my kids don't qualify for the$1 ,000 free seed money. I will open up an account if it becomes a work benefit for me. Again, matched money is good for me. I have custodial brokerage accounts for my kids. Personally, I love custodial brokerage 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 uh small amounts of tax gain harvesting within their accounts so the tax burden will hopefully will be less later.

23:05So that's an option for me. 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 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 uh 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 I want 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 or a house or whatever I literally struggle with retirement I want them to not struggle so a Trump account could be cool for just accepting family gifts

24:12so whether it makes sense it really depends on your situation I think more use cases will come out over time but that's my two cents I'm curious to hear yours though bro 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 also the kitty tax is um there is a kitty there is a free band of kitty tax it's small amount but um you can go ahead and um your long-term capital gains, zero dollars.

24:49So again, it's small amounts, so we're not messing with massive tax avoidance here. But yeah, if you're smart and you do it every single year while the kid is young, it can have a bigger impact later on. So that's my way to sort of make sense of not opening a 529 or going the Trump camera up. 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 TrumpAccounts, plural,.gov. Now, if you want the web version of opening the app, it's TrumpAccount.com. So singular.

25:32Now, 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. 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 do you have more investment options, but the distributions are tax free.

26:13And 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. There are some requirements about that, but it can be done. 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.

26:48You 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. Actually, I will say that opening an account for someone is pretty cool. I think back to when I was in my early 20s, I got my first job and all my 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 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.

27:29But imagine if an account was open for you, and even if there was only a few hundred dollars in it, it doesn't matter, or$1 ,000 that's grown over time, you see this account has already got your name on it. It's already a vehicle. So the hardest part is removed. So I do think that 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 yeah, I do think it is a good account. Well, Joel, this has been a great conversation. Thank you so much for joining us. Thank you very much for having me.

28:05Cheers.

28:34please check out our show notes. I'm Robert Brokamp. Fool on, everybody.