The Trouble with the Trump Accounts

My 1‑year-old son qualifies for a Trump Account, and I’ve opened it to claim the $1,000 government deposit. But I won’t be putting any of my personal after-tax wages in it, and neither should most parents. That is a shame. Trump Accounts are a good idea, poorly executed. A simple reform could make them worthwhile.

Normal investments get taxed twice. You pay taxes when you earn the money as wages, and then any profit you make on the investment gets taxed again at the lower capital-gains rate. Nearly every tax-advantaged investment account—401(k)s and individual retirement accounts, 529 plans for education—eliminates either the wage tax on the way in or the capital-gains tax on the way out.

A traditional IRA lets you make pretax contributions and taxes the withdrawals. A Roth IRA flips it: after-tax dollars in, tax-free out. The result is similar: Tax the money going in or tax it coming out, but not both.

Trump Accounts do both. The accounts accept after-tax dollars from parents and other authorized individuals, but when the child turns 18, they convert to traditional IRAs for retirement. That means the gains (along with the original $1,000) are taxed at withdrawal as ordinary income rather than at the lower capital-gains tax rate, which would have applied if the investment weren’t in a Trump Account. You pay taxes on the front end and the high rate on the back end. No deduction, no capital-gains rate, no flexibility.

If you are investing after-tax money for your children, a 529 plan is the better option for education savings. Money goes in after-tax, and qualified withdrawals are tax-free. Recent rule changes make 529s even better by allowing up to $35,000 to be rolled into the child’s Roth IRA, freeing the funds from the education restrictions. For general saving, a brokerage account allows the same after-tax contributions and keeps the lower capital-gains tax rate, with no restrictions on when you can touch the money.

The fix is easy: Lawmakers should pick a lane. Make contributions tax-free and then tax the withdrawals. That is how a traditional IRA works. Alternatively, keep the after-tax contributions and make the withdrawals tax-free, like a Roth. Either path would give parents an incentive to add their own money.

While they are at it, lawmakers should drop the lock-up rules and penalties, and instead let the savings roll into a more flexible account at age 18.

Under current rules, if a child withdraws funds before retirement for anything other than a short list of government-approved uses, such as college or a first home purchase, he owes an additional 10% penalty on top of ordinary income taxes. IRS data show lower-income households are the most likely to pull money out early, and few 18-year-olds will leave it untouched until they turn 59½. A penalty on early access is a tax on flexibility charged to the people who can least afford it.

The better design would be a Universal Savings Account. The owner could pull money out at any time, for any reason, without penalties. Canada and the U.K. have had similar accounts for years. There, simple, multipurpose accounts have allowed people to build personal savings for decades without a dollar of government subsidy. That is what a Trump Account should become when the child turns 18.

The idea behind Trump Accounts is sound, but Congress got the tax treatment wrong. Make contributions tax-free, and I’ll happily fund my children’s Trump Accounts. Until then, the $1,000 handout is where it stops. The rest I’ll save elsewhere.