TRUMP ACCOUNTS VS 529S VS UTMAS – WHICH IS BETTER?
Now that Trump accounts have come into play, families with children or grandchildren have more choices than ever for saving and investing for future generations.
A simple search will yield lots of good, factual information about the differences of each of these account types. But all that information might not help you figure out which makes the most sense for your particular situation.
With each account offering different features around funding, investments, withdrawals, and taxation, which account is best for your family? To answer that question, we suggest a different strategy: starting with the end in mind.
Is your ultimate goal to fund expenses associated with a child’s college education?
For an event down the road, perhaps in a child’s young adult or mid-life – like the purchase of a car, or a down payment on a house?
Or to jump-start the child’s retirement nest egg?
Once you have clarity around what you’d like the funds to be used for, then the process of deciding what type of account is best becomes simpler.
If your goal is to save for college, 529 accounts are your best bet. These college savings accounts are designed so that funds can be invested, and both the initial contributions and the growth can be withdrawn tax-free to pay for education-related expenses. 529 plans work best when they are funded early in a child’s life (more time for growth until the college years), and are among the most favorable accounts for families who plan to apply for need-based financial aid for college.
More upside to 529s: When/if the account has been in existence for more than 15 years, any leftover funds can be used to fund a Roth IRA for the child. Funds can also be passed among siblings or cousins, as needed.
If your goal is to contribute to an anticipated adulthood expense, like for the child’s new car, first apartment, or a down payment on a house, then an UTMA (or UGMA, in some states) may serve you best. These accounts have an adult custodian while the child – the beneficiary – is still a minor (until 21 or sometimes 18, depending on the state). Then the funds become the child’s, outright, when they become of age, and can be used however they’d like.
Downside: as you roll into the college years, the balance in any UTMAs is reportable on most financial aid forms as the child’s asset, and as such can reduce the child’s financial aid award by as much as 20%. Additionally, parents lose complete control when the child turns either 18 or 21, so if there are concerns about the child irresponsibly spending money, this structure might not be the best solution.
If your goal is to jump-start retirement funding, consider a Trump account (530A accounts). When compared to 529s or UTMAs, these accounts have their drawbacks. But when thought of as seed money for a child’s future retirement, their math and potential tax-free benefits are compelling. This Wall Street Journal article [LINK to the PDF b/c it’s behind a paywall??] outlines the optimal use for these accounts, which is roughly:
- Fund and invest the account each year until age 18 ($5,000 per year is the current maximum), at which point no further contributions can be made but the account’s tax structure becomes that of a traditional IRA;
- The child should wait until age 24 (past the reach of the kiddie tax) to convert it to a Roth IRA, knowing that he or she will pay income tax on the conversion (though better to do it in low-income years of young adults than to wait until the child’s tax bracket climbs higher via income increases or due to marriage)
- Then, grow grow grow the heck out of it this new Roth IRA until needed in retirement (after age 59½ the distributions will be both tax-free and penalty-free).
The Wall Street Journal’s example and assumptions outlines a case where this may yield a Roth IRA at age 59½ of over $3 million, for the low low price of $5,000 per year for 17 years ($85,000 total) plus a payment in year 24 of almost $44,000 in taxes – a total of $129,000 spent overall.
Drawbacks: This strategy is contingent upon all involved parties understanding that this is meant to be a long-term tax-advantaged retirement funding strategy – a feat that may or may not be able to come to fruition, depending on how the child cares for the account over many decades.
Nowadays parents and grandparents seemingly have multiple options for funding children’s initiatives. Much has been written about each of these types of accounts – we suggest that it’s best to start with how you expect the funds to ultimately be used, and then work backwards to determine the best account to support your goals. Feel free to reach out if you would like help noodling through any of these various account and investment options.
