Welcome! Today, we’ll delve into the shortcomings of the Trump Account scheme and discuss more effective alternatives for saving for college. It’s essential to make informed financial decisions for your children’s future.
By Dean Baker, co-founder and senior economist at the Center for Economic and Policy Research. He is the author of several influential books, including “Getting Back to Full Employment: A Better Bargain for Working People,” “The End of Loser Liberalism: Making Markets Progressive,” “The United States Since 1980,” “Social Security: The Phony Crisis” (with Mark Weisbrot), and “The Conservative Nanny State: How the Wealthy Use Government to Stay Rich and Get Richer.” Dean also runs a blog called “Beat the Press,” where he critiques media coverage of economic issues. Originally published at Common Dreams
I genuinely mean it when I say there’s little reason for most people in this country to invest a single dollar into a Trump account for their children.
First, let’s clarify that I’m not advocating for tax-sheltered accounts as a whole. In my view, they are largely an inefficient means of achieving public objectives, particularly in making education more affordable. A more effective approach would involve allocating more public funds to support public and community colleges.
Furthermore, tax-sheltered accounts tend to benefit higher-income individuals disproportionately. Over a quarter of households pay no income tax, meaning they would gain nothing from investing in a tax-sheltered account. An additional 20 percent fall within the 10 percent tax bracket, resulting in just a 10-cent savings on every dollar put into the account. In contrast, individuals in higher income brackets save 37 cents on each dollar invested.
Moreover, these accounts funnel substantial funds into the financial industry. Tens of billions of dollars go toward the administration of these accounts, creating unnecessary bureaucratic waste.
To the scheme’s credit, Trump accounts cap fees at 0.1 percent of assets, which is lower than many alternatives. However, this point pales in comparison to the availability of low-cost investments in other vehicles. Stock index funds, for example, generally carry the lowest fees, and it’s prudent for most to take advantage of them. Although some will claim they can outperform the market, most investors do not, leading to wasted money on higher fees and trading costs.
Regardless of how one feels about the existence of Trump accounts, the key question is whether these accounts can effectively aid in saving for children’s futures. As I mentioned, the answer for almost everyone is no.
The primary reason is that we already have 529 plans designed for education savings. The significant distinction is that funds in a 529 account can be withdrawn if needed, while Trump accounts prohibit any withdrawals until the child reaches 18 years of age.
Sure, there’s a penalty for early withdrawals from a 529 plan, yet the option for access remains if an unexpected financial circumstance arises. Life is unpredictable; job loss, medical emergencies, or divorce can all necessitate tapping into savings. With a 529 plan, you have some level of access. With a Trump account, you’re left empty-handed.
It’s important to note that non-educational withdrawals are relatively common. A recent study by Vanguard indicated that approximately 2 percent of accounts experience an unqualified withdrawal each year. If an account remains open for an average of 20 years, this suggests that around 40 percent have made such withdrawals at some point. Life rarely goes as planned.
Moreover, the penalty only applies to the earnings portion of a 529 plan rather than the entire balance. For example, if someone withdraws $5,000 from a 529 plan with 40 percent of that being earnings, they’d only pay taxes and a penalty on the $2,000 earnings. If they are in the 10 percent tax bracket, they would owe $200 in taxes and an additional $200 penalty. Conversely, if they are in the zero tax bracket due to circumstances such as job loss, they would only incur the $200 penalty. This flexible access is unavailable in Trump accounts, where investors can’t touch their funds until age 18, and the gains are taxable.
In addition, transactions within a Trump account are severely limited. For instance, if your child is 17 and you are concerned about a potential market downturn, you cannot adjust your investment to something safer, like Treasury bonds. You’re stuck riding the waves of market fluctuations.
Perhaps the most absurd claim made by supporters of Trump accounts is that they can be rolled over into an IRA for lifelong wealth accumulation. This is also possible with 529 accounts, subject to a cap of $35,000.
Trump advocates liken the $35,000 ceiling to a significant injustice, but in reality, only wealthier individuals would even notice this cap. The vast majority of people never accumulate over $35,000 in a 529 plan, and those who do will often find themselves with education-related expenses that keep the account under this threshold. Educational costs can include not just tuition but also housing and food.
However, let’s assume someone does accumulate over $35,000 and wishes to roll it into an IRA. They would incur a 10 percent penalty on any amount exceeding $35,000, translating to a $500 penalty on a $5,000 excess. They would also be responsible for taxes on that same $5,000, as it would be taxed to the beneficiary, likely placing them in a lower income tax bracket as they begin their career, possibly at 10 percent or even zero.
So, this is the dismal scenario that proponents of Trump accounts suggest we avoid in favor of investing in them? This rationale seems misguided, and any financial advisor pressuring you to opt for a Trump account should be reconsidered.
Lastly, regarding the $1,000 Trump proposes to give newborns, wouldn’t it be wiser to allocate tax dollars toward food and healthcare for children from low-income families rather than dispersing $1,000 checks to families who don’t require it? While refusing the funds won’t change policies, if you find it bothersome, consider donating the money to a worthy cause. It’s important to take the funds but avoid investing further in Trump accounts.
