Exercise Caution Before Contributing to Your Grandchild's “Trump Account”

The new 530A accounts might not be a fit for gifts to grandchildren.

Every year, many of our clients make gifts to grandchildren up to the federal annual gift tax exclusion — currently $19,000 per grandchild ($38,000 for a married couple who elects gift-splitting). Gifting is one of the most straightforward and reliable tools in an estate plan: move wealth out of your taxable estate to help a younger generation without filing a gift tax return or reducing your lifetime gift and estate tax exemption.

Gifting can play an important role in estate planning

Our attorneys typically see grandparents’ gifts go into a 529 plan, a custodial UTMA/UGMA account, or an irrevocable trust. Now there's a new option in the mix: the Trump account (also known as a 530A account), which is an IRA created by the federal government for eligible children under the age of 18.

Because these accounts are new and there are several unanswered questions about them, grandparents must be cautious about gifting their own funds to a grandchild's 530A account. If you are a grandparent accustomed to the flexibility of a 529 or a custodial account, you might be surprised to learn that a 530A account behaves quite differently in ways that matter — both for your grandchild's eventual use of the money and for the mechanics of your annual gifting plan.

Here are some things grandparents must understand before writing that check.

1. The money is completely out of reach until your grandchild turns 18 — no exceptions

Most gifting vehicles for minors allow some flexibility. Funds in a 529 account can be withdrawn for the beneficiary's education at any age. Similarly, a UTMA/UGMA account lets the custodian spend money for the child’s benefit when the child is a minor.

A 530A account works much differently. No withdrawals are permitted before age 18, full stop — money cannot be withdrawn for education, hardship, emergencies, or any other reason. For example, if your grandchild has an uninsured medical bill or their parents need help paying tuition at a private elementary school or high school, the money you gifted into their 530A account cannot be used for those expenses. Instead, it stays locked in the account.

If one of your goals is having the flexibility to use the money during your grandchild's childhood, a 530A account will not deliver that, whereas a 529 account, a custodial account, or a well-drafted trust will.

2. Funds withdrawn at age 18 or later — even for educational expenses — come with a tax bill and might reduce student financial aid

Consider the income tax imposed on withdrawals

The IRS treats 530A accounts as traditional IRAs, taxing earnings and most contributions as ordinary income when money is withdrawn — even if used for qualified education expenses. While qualified education expenses avoid the 10% early withdrawal penalty, withdrawals made for other purposes before the grandchild turns 59½ will be assessed both the early withdrawal penalty and income tax.

A 530A account is structured like a retirement account, but many grandparents gift with college or other postgraduate education in mind, not retirement. The practical outcome of this mismatch is significant. Consider a grandfather who contributes $5,000 when his grandchild turns one. If the contribution grows at 6% annually until the grandchild is 19, both a 529 account and a 530A account would end up with $14,271.70. The full amount comes out tax-free from a 529 plan when used for qualified education expenses; however, with a 530A account, only the original $5,000 comes out tax-free. The rest ($9,271.70 of growth) is taxed as ordinary income.

If assistance for education is your primary objective, a 529 plan remains the best option.

It is also important to note that the Department of Education has not yet issued official guidance on how 530A accounts will be treated on applications for federal student aid (FAFSA). Many experts believe a 530A account will be a student asset on the FAFSA, which would lower student aid by 20% of the account value — so a $10,000 balance in a 530A account could mean up to $2,000 less in grants for the student. As far as withdrawals are concerned, other experts worry about another problem. If withdrawals count as student income on the FAFSA, they will reduce student aid by 50 cents for each dollar withdrawn. These are open questions that still need to be answered.

3. Your gift may not qualify for the annual exclusion the way you'd expect

This is a subtler point and one we're watching closely as guidance develops. The federal gift tax annual exclusion generally applies only to gifts of a present interest — meaning the recipient (or someone acting for them) has an immediate, unrestricted right to use, possess, or enjoy the gifted property. For example, the custodian of a UTMA/UGMA custodial account can spend the funds for the grandchild's benefit at any time, and that's the reason gifts to custodial accounts are treated as present-interest gifts even though, in Indiana, ownership is not turned over to the grandchild until age 21.

A 530A account is the opposite. The funds are 100% inaccessible to anyone until the grandchild turns 18. Even the grandchild’s parents are not permitted to withdraw from the account to pay for something for the grandchild. That kind of restriction has historically raised present-interest questions for other gifting vehicles (it's the same underlying issue that made "Crummey" withdrawal rights necessary for certain trusts). 530A accounts are new, but we do know that they do not give the child or a custodian a present interest that can be accessed. The IRS has not specifically addressed whether contributions will nonetheless qualify for the annual gift tax exclusion, so this is a genuinely open question.*

We are not suggesting that you assume your gift will fail to qualify for the annual exclusion — but we are suggesting that you not automatically assume it will qualify either. This is exactly the kind of issue that must be resolved before you decide to commit a meaningful annual exclusion gift to one of these new accounts, particularly if you're gifting at the higher end of the exclusion amount each year.

4. The $5,000 contribution cap is per account, not per contributor, and may trigger an annual excise tax if exceeded

Unlike the gift tax annual exclusion (which is a per-donor, per-recipient limit), Internal Revenue Code §530A caps the total combined contributions to a 530A account from parents, grandparents, other relatives, friends, etc., at $5,000 per year. All contributions are added together to determine if the cap has been reached for the account in any given year.

If you, other grandparents, and other family members are all gifting to a grandchild's 530A account, the account can easily exceed the cap without any one person intending it to. Excess contributions to IRA-type accounts generally trigger a 6% excise tax on the amount exceeding the cap. Excise tax is owed in each year the excess contribution remains in the account. Contributions to a 530A account from all contributors must be coordinated to avoid exceeding the $5,000 cap — something a 529 plan, with its much higher contribution limits, does not require.

5. You will not control the account

Control over money you gift into a 530A account for a grandchild is held by a "responsible party" — a term defined by the new law but generally a parent or another qualifying individual if no parent is available. As a grandparent, understand that you are unlikely to be the person managing investment decisions or account administration, even though the money came from you. If maintaining some influence over how the funds are invested or how they are eventually used matters to you, an irrevocable trust for the grandchild's benefit, where you can set the terms and manage assets yourself, may serve that goal far better than a gift into an account controlled by someone else.

The authority of the responsible party ends when the grandchild turns 18. As the account owner, the grandchild will then decide whether to keep the account in place or close it, take the tax hit, pay the early withdrawal penalty, and spend what is left.

The bottom line

A 530A account is not a substitute for a 529 plan, a custodial account, or a trust, and treating it as a drop-in replacement for your usual annual exclusion gift could produce unintended results: money your grandchild can't touch for 18 years, a tax bill at withdrawal, a 10% penalty for early withdrawals, excess contributions triggering excise tax, or — depending on how the present-interest question eventually resolves — a gift that doesn't qualify for the annual exclusion, requiring you to file a gift tax return and reduce your lifetime gift and estate tax exemption.

Before your next round of annual exclusion gifts, consider how a 530A account fits — or doesn't fit — alongside the tools you already have in place for your family.

*Generation-skipping transfer tax issues are beyond the scope of this article, but GST tax must also be considered when making gifts to or for the benefit of grandchildren.

This post is for general informational purposes and does not constitute legal or tax advice for any individual. Every family's situation is different, particularly where new and evolving rules like those governing Section 530A accounts are concerned.

Troyer & Good, PC 6303 Constitution Drive, Fort Wayne, Indiana 46804 troyergood.com