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By Abby Schultz

No one should turn away free money, especially parents struggling to get by, let alone save for their children's future, but Trump accounts — seeded for newborns with $1,000 by the federal government — may not be the best option.

There are several reasons that parents and guardians may want to consider other vehicles. One is that Trump accounts become traditional individual retirement accounts when a child turns 18. That means any earnings from a Trump account will be included in the child's total unearned income and taxed for the year if withdrawn before he or she turns age 59 1/2 .

Those withdrawals may also be subject to a 10% penalty unless the funds are used for higher education. A beneficiary can also use $10,000 toward a first-time home without penalty.

"I would suggest parents take this free money if it's available to them, but then I wouldn't focus much of my energy on saving more into that account unless you have fully exhausted all of your other savings options," said Kate Ashford, a wealth management specialist at NerdWallet, in an interview.

Other options include Roth IRAs, 529 education plans, and custodial accounts such as UGMA and UTMA. Each has pluses and minuses but generally offer more flexibility, and some tax advantages, relative to the Trump accounts.

Among concerns that experts have with Trump accounts is a $5,000 cap for contributions outside of gifts provided by the government (including state and local governments), philanthropists, and charitable groups.

For families who may not have the means to save, the cap won't be a deterrent. "But for people who are trying to save a lot toward college...that is a cap to keep in mind," Ashford said.

Trump accounts were created in July through federal tax and spending legislation, and can be set up and funded beginning on July 4, 2026, according to the government, which released guidelines on Tuesday. U.S. citizens who were born this year through 2028 will each receive $1,000 in their accounts, once they are activated. But parents and guardians can open a Trump account for any child under age 18.

Funds in these accounts grow tax-free, but contributions from family and friends are made with after-tax dollars. Contributions into custodial accounts — including UGMA and UTMA accounts as well as Roth IRAs — also are made with after-tax contributions, but the majority of states allow for varying levels of tax deductions for 529 plans.

An advantage of 529 plans is that withdrawals are entirely tax-free if spent on education, Ashford says. That can include higher education, but also K-12 tuition or trade school.

In addition, the parent or guardian is in control of the account, while a Trump account will be controlled by the child after they are 18, meaning that it may count "significantly against their ability to access financial aid," said Adam Frank, head of wealth planning and advice at J.P. Morgan Wealth Management, in an interview.

Another advantage of a 529 plan is that any unused funds can be transferred to someone else, which isn't the case with a Trump account, according to Dianne Mehany, EY Private's national tax leader.

Dell Technologies founder and CEO Michael Dell and his wife, Susan, announced on Tuesday that they would put $250 in the accounts of 25 million children ages 10 and under born in 2024 or earlier who live in areas with a median family income of $150,000 or less. Their gift — from various charitable vehicles — amounts to $6.25 billion.

Contributions by philanthropists such as the Dells, by charitable organizations, and by state and local governments don't count toward the $5,000 annual cap. Similarly, the $1,000 from the federal government also doesn't count toward the cap.

The fact gifts such as these can exceed the $5,000 limit is a clear benefit in encouraging families to save — whether the money is used for education, homeownership, or starting a business, Frank says.

"But compared with a custodial account — a plain-vanilla UTMA or UGMA — these accounts are a little bit more restrictive," he says. "It isn't clear that this is going to be a better place for parents to contribute money."

One reason that Frank prefers custodial accounts is they allow the parent or guardian to invest the assets in a range of financial choices, not just a low-cost equity index fund or exchange-traded fund, as the Trump accounts require.

Another benefit is flexibility: "That money can be pulled out and used for anything," Ashford says.

One plus of Trump accounts is that employers can contribute to them, with the first $2,500 per employee a year excluded from the employee's income.

But Mehany notes that the $2,500 employer cap is per employee, so if a worker has two children, they would have to split the contribution between them. Also, although the contribution would be tax-free to the employee and their child, the distributed funds are ultimately taxable to the beneficiary, Mehany said in an email.

Write to Abby Schultz at abby.schultz@barrons.com

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