If you would like to make a tax-advantaged gift to your child or grandchild you now have four good choices: 529 plans, Trump Accounts, IRAs, and long-term savings held in a UGTMA account or in trust.
529 plans remain the “gold standard” for education-specific saving. Contributions grow tax-deferred and withdrawals are tax-free when used for qualified education expenses. Many states also offer a state income tax deduction or credit for contributions, which neither Trump Accounts nor IRAs offer. Contribution limits are high, and you may retain control over the account even after the child becomes an adult.
The tradeoff is that money used for non-education purposes gets hit with ordinary income tax plus a 10% penalty on earnings, so it's a poor choice if you're not confident the child will pursue higher education, trade school, or other qualified paths. The good news is that if the beneficiary does not need the funds, they can generally be transferred to a wide range of qualified family members to preserve the tax advantages. Also, it is possible to roll a portion of the unused 529 funds into a Roth IRA without the penalties. Bottom line, if you are funding education as a primary goal, this is the way to go, but don’t overdo it.
Trump Accounts can be opened by parents or guardians and funded with after-tax dollars. Children born between January 1, 2025, and December 31, 2028 are eligible to receive a one time $1,000 “seed” contribution from the government. This is essentially “free money.” Almost anyone, including the child, can add additional money to the account once it's established, with a combined annual family limit of $5,000 per year. These accounts follow traditional IRA tax rules once the child turns 18. Until then, funds must be invested in a limited menu of low-cost index funds. The obvious appeal is the $1,000 “free” money and long tax-deferred growth from birth until retirement. Because these accounts are taxed as traditional IRAs, withdrawals will eventually be taxed at high ordinary income tax rates. As a result, there may be better places for additional gifts.
Roth IRAs work only if the child has earned income (a part time job, modeling, acting gigs, summer jobs, working in a parent’s business, etc.), since IRA contributions are capped at the amount of income earned or the annual IRA limit, whichever is less. The big advantage is the potential for decades of tax-free compounding. A Roth IRA started at 16 has 50+ years to grow tax-free. Don’t forget that once the child turns 18 (or the age of majority in your state), they gain full control of the account. If longer term control is a concern, consider the trust option.
UGTMA or Trust: depending on how long you want to maintain control of the gift, it can be very tax efficient to make a gift of low-yielding index funds and simply hold them. With no turnover and little yield there will be little to no tax burden until the investments are liquidated. When that happens, tax will be paid at favorable long-term capital gain rates. No ordinary income, no RMDs, and no ordinary income tax rates.
Many families will end up using a combination of these strategies to optimize their family planning rather than picking just one. Talk to your HCM Advisor to work through the options for your family’s multigenerational tax advantaged gifting plan.