Trump Accounts vs. Custodial Accounts: What Parents Should Actually Care About (EP.251)

0:29We all need to make smart decisions with our money. what's happening a bit with the Trump accounts, which is a new tax-advantaged way to save for a child and doesn't perfectly match anything families have had before. It has some features that make it resemble a retirement account and others that make it feel a bit like a child's savings vehicle. So in this episode, I want to walk through how these accounts work and more importantly, how they compare to other tools families already have for saving for a child. Because to me, this is less about whether Trump accounts are good or bad. The better question is what leaves a child in the best position after taxes with the most flexibility and the fewest future headaches.

1:11As always, you can find detailed show notes at thelongterminvestor.com. And while you're there, you can also sign up for my newsletter that comes out every other Wednesday. The next edition of the newsletter will have an exclusive download detailing all the different child savings account options, and I'm not going to be publishing that anywhere else. So head over to thelongterminvestor.com to sign up for my newsletter or use the link at the top of the episode description. Now, why are Trump accounts so appealing? Well, I think there's something powerful about the idea of starting a child early with a dedicated investment account.

1:47The earlier the money goes in, the more time it has to compound. And when you combine that with a tax-advantaged wrapper, it's easy to see why parents and grandparents will be drawn to it. So let's cover some of the basics. Currently, you can contribute$5 ,000 a year, and those contributions to the Trump account are made with after-tax dollars. So there generally isn't an upfront deduction, but the savings grow tax-deferred. It's a lot like a non-deductible traditional IRA. The big difference, though, is that Trump accounts don't require the child to have earned income, which has historically been a barrier for people who wanted to contribute to a child's retirement account.

2:25Another attractive feature that I think is going to cause these accounts to get a lot of attention is that so many different type of people can potentially fund them. Parents, grandparents, relatives, friends all can contribute. Employers can also contribute up to$2 ,500 per year under the current guidance, although the IRS has indicated that employer contributions will count towards that general $5 ,000 annual limit. But there can also be these contributions from governments or charities that are treated differently and generally do not count towards that cap. So when these accounts were announced, there was a grant of$1 ,000 for all children born before a certain date.

3:03And so that's a situation where, hey, this is free money. This is going to be a great account to set up. Now, what happens when the kid actually wants to use the money? And I think this is where the account starts to look more like a traditional retirement account, because in general, this is not meant to be a spendable account during childhood. And once the child reaches age 18, the account is expected to convert into a traditional IRA. And then from that point forward, the usual IRA framework takes over. That means after-tax contribution portions can come out without being taxed again. but the growth, along with any untaxed employer, government, or charitable contributions, would generally be taxed as ordinary income when withdrawn.

3:45And if the money is taken out before the normal retirement account rules allow it, penalties may apply. So we basically have a traditional IRA for kids here. But that doesn't have to be a bad thing. I mean, let's think about the numbers. Suppose you contributed$5 ,000 per year for a child or a grandchild or a niece or a nephew or a friend, for the first 18 years of their life, and the account earns 8 % annually, that account would be roughly worth$202 ,000 by age 18. And of that amount,$90 ,000 would be contributions, and about$112 ,000 would be investment growth. So I think that's enough to make any parent or grandparent stop and pay attention.

4:24And if the beneficiary did nothing else with the account other than let it continue to compound at that same 8 % annual rate, it could grow to roughly$5.1 million by age 60. And that's why people like these accounts. And to be fair, I agree it's pretty compelling. But I know from working with our clients, and I know this is going to be true for many of you listeners, that when it comes time to take the money out and you have this big tax bill to deal with, you suddenly are wondering, did I allocate my savings correctly? And I think tax deferral just isn't automatically better. It's one of the easiest mistakes in tax planning is just assuming that by delaying the taxes is automatically going to improve the outcome.

5:06And sometimes it does, but sometimes it absolutely does not. And because the Trump accounts borrow heavily from the traditional IRA playbook, they can create some of the same issues that make large traditional IRAs tricky later in life. The longer the money compounds, in that example I gave you, huge compounding, the larger the share of the account that may be eventually taxed as ordinary income. And ordinary income tax treatment, as we all know, is usually much less attractive than qualified dividends or long-term capital gains treatment in a taxable account. And I think that is the part that many people are going to miss with these Trump accounts.

5:43The same feature that makes the account sound so powerful at the beginning, the decades of uninterrupted tax-deferred growth can create a very different outcome down the road when the money starts coming out. There's also, and this may seem small, but to me, it really isn't. There's also this record keeping issue that just shouldn't be ignored because Trump accounts are going to contain both after tax contributions and amounts that have never been taxed. And someone has to keep track of what portion of the account has already been taxed. And that responsibility may start with a parent or guardian, but eventually it gets handed off to the child.

6:18And if that record keeping slips over time, the tax consequences get pretty messy. I think this is just a reminder that complexity has cost even when the account itself sounds attractive. So I do think, in general, when you're thinking about saving for a child, a plain custodial account may be better than you think. A lot of people underestimate the simple option. And when people hear taxable account, they often assume inferior, but taxable does not automatically mean worse. I think that a taxable custodial account can be surprisingly efficient if the family understands how the tax rules work and they manage the account thoughtfully.

6:56Under the kiddie tax rules, a child can have some unearned income taxed on very favorable terms. So in 2026, the first$1 ,350 of unearned income is effectively sheltered. Then the next$1 ,350 is taxed at the child's rate. And then only after that do you generally start running into the parent's marginal rate. And that creates an opportunity. A family could realize some gains along the way, reinvest the proceeds, and steadily increase the child's cost basis over time. And that higher basis matters because it means less embedded gains later. It means less future tax when the money is eventually accessed.

7:35And it means that the account is not quietly building towards one large future ordinary income problem. And that's why I think a custodial account can look less impressive at first glance, but still produce a cleaner after-tax outcome. But taxes are only part of this. I do think for many families, the bigger advantage of the custodial account may just be flexibility. A retirement account is built around retirement account rules, and that means access is more limited, tax planning is more complicated, and the money is effectively being told what its job is far in advance. A custodial account does not solve every problem, but it does keep your options open.

8:17And I think that matters more than people realize because maybe the money helps with the first car. Maybe it becomes part of the down payment one day. Maybe it turns into a young adult's first real brokerage account, or maybe it simply stays invested and becomes an early financial foundation. That flexibility has real value, especially when families are saving for a child, but not really certain yet what the eventual goal will be. Now, where do 529 plans fit into all this? None of this means the 529 plan suddenly become less useful. In fact, if the primary goal is education, I still think a 529 deserves first consideration.

8:55A 529 gives you tax-deferred growth and tax-free withdrawals for qualified education expenses. And now there is also a limited ability to roll unused 529 assets into a Roth IRA for the beneficiary, subject to the rules. I mean, there's a bunch of rules. There's a rollover opportunity cap at$35 ,000 over the course of a lifetime. The 529 must have generally been open for at least 15 years. The beneficiary has to qualify for a Roth anyways. And I think in general, there's lots of rules around it, but it does create a little bit of flexibility and maybe eases that concern of what if I save too much.

9:32It doesn't eliminate the concern entirely, but it gives families a more graceful off-ramp than they used to have. And look, I think in general, I'm covering all these accounts because it's not really a winner-take-all contest. I think it's better to think about these accounts based on the job the money is supposed to do. So if the goal is education, a 529 often makes the most sense. If the goal is broad flexibility and tax-managed investing for a child, I actually think the custodial account may be the more attractive option, far more than people realize at least. And if the goal is to capture a government seed contribution or take advantage of a new account structure specifically, a Trump account can have a role.

10:14But that is very different from saying it should automatically become the default home for every dollar saved for a child. Now, one major caveat has to be part of this discussion because people always ask, Custodial accounts can have a negative impact in financial aid calculations. It doesn't invalidate the case for custodial accounts, but it does mean families who expect need-based aid to matter should be thinking carefully before treating a custodial account as the obvious answer. I'm actually going to cover 529s in more detail next week, but I think the bottom line here is that the right way to evaluate any savings vehicle is to ask a better set of questions.

10:53What is the money for? How flexible does it need to be? What will the after-tax outcome likely look like, not just next year, but decades from now? And what complexity am I introducing in exchange for the perceived tax benefit? For many families, the surprising answer may be that a plain old taxable custodial account is not the compromise option. It may actually be the smarter one, but that does not mean that the Trump accounts are useless. They may absolutely make sense in some situations, especially where outside contributions create free money. And again, the best solution is not always the one that sounds the most exciting.

11:30It's often just the one that leaves you with the fewest regrets later. Again, you can go to thelongterminvestor.com for detailed show notes on this episode, as well as a place to sign up for the newsletter where the next issue is going to have an exclusive download that details all the different pieces of the different child savings account. That newsletter comes out every other Wednesday, you can sign up for it at thelongterminvestor.com or use the link at the top of the episode description. As always, thanks for listening. And until next time, to long-term investing. Thanks for listening to the Long-Term Investor podcast.

12:07To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.