Motley Fool Hidden Gems Investing - Trump Accounts Are Live, But Are They the Best Choice?

Starting point is 00:00:00 Trump 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. 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 4th, they could now also be funded. Here to join me to discuss the details, pros, and cons of Trump

Starting point is 00:00:46 Accounts is my foolish colleague, Joel O'Leary, prolific personal finance writer over at Motley full of 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. The way I think about Trump accounts is that they're basically an IRA, but for kids. So like a retirement account, but for kids. And you normally need earned income before you can contribute to a retirement account uh but in this case uh parents 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

Starting point is 00:01:35 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 five thousand dollars 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 kick-starting their retirement so uh that yeah that's that's basically what the new trump accounts are i'll Let's add that the idea for these accounts have actually been around for more than 15 years, though the terms have changed. They originally proposed as baby bonds and then American

Starting point is 00:02:23 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 uh well we'll start with the 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 a thousand dollars for each baby born uh that meets a certain criteria uh and free money doesn't come all

Starting point is 00:03:07 that often in personal finance so if your kid is eligible this you you want to jump on it So here's the criterion. 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 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 three thousand dollars is uh is 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

Starting point is 00:03:53 it's like an ira so you get tax deferred growth right but it's not tax deductible correct correct so um i will say people say tax advantage to count 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 kids 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

Starting point is 00:04:44 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. Right so as we read about Trump accounts you starts 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 uh advantages this is a brand

Starting point is 00:05:35 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 job, they can make Roth conversions in small amount 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. Roth IRAs are very flexible when it comes to withdrawals and things like that. So yeah, absolutely. I think that's a really powerful advantage.

Starting point is 00:06:20 Yeah. And as you read about this strategy, you'll come across the pros and cons of it. First of all, 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 parent's 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 uh benefit of trump accounts or at least in your mind and in mine is what my mind as well in terms of the investment choices within

Starting point is 00:07:02 the account yeah 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're not going to get swindled by advisors or people that can take fees for not providing value. You're not going to underperform the market because all your investments are invested in the broad market so um it really is a um a boring investment account

Starting point is 00:07:53 which is perfect for most people 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%, which 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. So anyway, I'm a huge fan of it. I think this limited investment menu is a pro. What do you think, Robin? Yeah, so I'm a big believer in index funds. When my wife and I open brokerage accounts for our kids, we always start 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

Starting point is 00:08:46 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. And 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.

Starting point is 00:09:22 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 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 play benefits package that'd be that'd be really nice uh any free money we can take uh is great and uh you know you say that

Starting point is 00:10:20 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 $2,500 among the three kids and that $2,500 does go towards the $5,000 limit but money from government or non-profits does not go to that limit so you can put the $5,000 on top of all that. Stop wasting your nights on a mattress that doesn't get you. Experience the most comfortable

Starting point is 00:11:18 mattress in the world the sleep number smart bed at the touch of a button you can personalize your comfort choose firmer or softer adjust cooler to warmer and right now save up to twenty five hundred dollars during our massive labor day event hurry into your local sleep number store today because we have your number 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 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

Starting point is 00:12:15 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 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 all right so then the kid turns 18 and and at that point by the way they have control over it then what happens

Starting point is 00:13:02 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 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. There are some penalty free use cases. So for example, using the money for higher education, or you can withdraw withdrawal money or buying a first down payment on a home up to a certain limit. I think it's $10,000. That may change. So there are some qualified withdrawals, but for the most part,

Starting point is 00:13:50 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 checking 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. Yeah, that's another downside. And sort of

Starting point is 00:14:35 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. And you might be tracking it literally for decades, so it can be a challenge. And again,

Starting point is 00:15:20 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 contributions to a Trump account. That's the same formula 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. You know, they have limits for a reason because if they don't, you know, people that can gift large sums can can move money around and take advantage so for all you like mega rich people

Starting point is 00:16:04 trying to drop 50k into their kids uh trump account that you can't do that um so the five thousand dollar 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 on their wealth. This is not an account for doing massive amounts like that. 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

Starting point is 00:16:51 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. So I just want to highlight that as another potential downside. Yeah, you know, Rona, actually, let's dive into that because I was just thinking the other day, people already are rating 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.

Starting point is 00:17:28 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, they 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

Starting point is 00:18:06 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 yeah, I do think turning over control to your kids at 18 is a scary one. 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. all right joel give us your final verdict who should consider trump accounts and who should perhaps consider another type of account 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

Starting point is 00:19:00 your kid later but claim it now because the earlier you can invest that money uh that three thousand dollars uh the 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 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 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

Starting point is 00:19:47 see Trump accounts having 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 use that money or exit options. If you've got a working teen uh rough ira is just get started with that a custodial rough ira they need earned income but you know you avoid everything like all taxes going forward it's 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 uh benefit for me that's uh again that's um matched money is is good for me um i have custodial brokerage accounts for my kids personally i love custodial brokerage accounts

Starting point is 00:20:35 just because uh 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 to them and they can do whatever they want with it. I am, I mean, I don't want to get into the weeds, but doing some small amounts of tax gain harvesting within their accounts.

Starting point is 00:21:05 So the tax burden will be less later. So 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 all. so um yeah those are the other options that i'd consider there will i 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

Starting point is 00:21:41 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 on their 18 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 a house or whatever like i literally struggle with retirement i want them to not struggle so here so a trump account could 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, but that's my two cents. I'm curious to hear yours though, bro.

Starting point is 00:22:27 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. 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 manage it properly, but i love that you're doing that also the kiddie tax is um there is a kiddie there is a free band of kiddie tax it's small amount but um you can go ahead and um your long-term capital gains zero dollars 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

Starting point is 00:23:11 529, or going the Trump cap route. 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.gov. 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

Starting point is 00:23:59 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. 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. There's 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, you know, the Trump account is not the one for you. A regular custodial

Starting point is 00:24:41 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 or 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, five, six, seven, 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. I know I needed to, but it was also like, you know what, can I just do it later? What are

Starting point is 00:25:24 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 so i do 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, yeah, I do think it is a good account. Well, Joel, this has been a great conversation. Thank you so much for joining us.

Starting point is 00:26:08 Thank you very much for having me. Cheers. 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 investments 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.

Starting point is 00:26:36 To see our full advertising disclosure, please check out our show notes. I'm Robert Brokamp. Fool on, everybody! Thank you.

Motley Fool Hidden Gems Investing - Trump Accounts Are Live, But Are They the Best Choice?

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