Trump Accounts are a new child-savings vehicle with the potential to become a powerful long-term planning tool. Parents, employers, and advisors are already asking the key question: what is the best way to get money into the account?
The answer may not be a direct contribution. And it may not even be a direct employer contribution. In many cases, the most tax-efficient path may be an employee’s pretax salary-reduction contribution through a Section 125 cafeteria plan, if the employer offers that option.
To briefly review what a Trump Account is, Trump Accounts are special accounts for children under age 18. Contributions can grow tax-deferred, and once the child reaches 18, the account generally becomes subject to traditional IRA-style rules, with funds potentially available for education, a first-time home purchase, or retirement. That makes the account useful regardless of how it is funded. But the funding method can dramatically affect the tax result. And for families that later take advantage of strategic Roth conversions, the account may ultimately provide what could be described as a quadruple tax benefit.
Direct Contributions: Useful, but Limited Tax Savings
A direct contribution to a Trump Account is generally made with after-tax dollars. That means the account owner receives the benefit of tax-deferred growth, but the contributor does not necessarily get an upfront deduction or income exclusion for the contribution.
In that sense, a direct contribution resembles a nondeductible contribution to a traditional IRA. The money can grow tax-deferred, which is valuable. But the contributor has already paid income tax on the dollars going into the account.
That gives you tax benefit number one: tax-deferred growth.
That is good. But it is not the best possible outcome.
The other drawback is recordkeeping. If direct after-tax contributions are made, someone will need to track basis. That basis will matter later when distributions are taken or when the account is converted to a Roth IRA. Families that make direct after-tax contributions will need records of contributions later to establish how much of the distributions are taxable.
Direct Employer Contributions: Better, but Still Not Perfect
Employers may also contribute to Trump Accounts through a Trump Account Contribution Program. If properly structured, employer contributions can be excluded from the employee’s gross income for federal income tax purposes.
That sounds like a major improvement over direct after-tax contributions. And in some ways, it is. If an employer is offering a true additional contribution—free money—the employee should generally take it. Free money is still free money.
But direct employer contributions appear to have an important limitation: they may still be subject to FICA tax, even though they are excluded from income tax. In other words, the employee may avoid federal income tax on the employer contribution, but the contribution would still be treated as wages for Social Security and Medicare tax purposes unless Congress fixes this problem.
That means a direct employer contribution may give you tax-deferred growth and an income-tax exclusion, but it may not provide the payroll tax savings.
So direct employer contributions give you two tax benefits, but not three.
There is also a practical point. Employers do not make compensation decisions in a vacuum. Even when a benefit is presented as an employer contribution, the cost is usually part of the employer’s total labor budget. If the employer is choosing between wages, bonuses, retirement contributions, health benefits, and Trump Account contributions, employees should still care about which structure produces the best after-tax result.
The Section 125 Cafeteria Plan Route: The Triple Tax Benefit
The most attractive structure may be employee salary-reduction contributions through a Section 125 cafeteria plan, if the employer adopts the required Trump Account contribution program and permits this feature.
Here is why.
Instead of receiving taxable wages and then contributing after-tax dollars to a child’s Trump Account, the employee elects to reduce compensation and have the amount contributed through the cafeteria plan to the dependent child’s Trump Account.
This can create three tax benefits.
First, the money grows tax-deferred inside the Trump Account.
Second, the salary-reduction contribution is made on a pretax basis, creating an upfront income-tax benefit similar to a deductible traditional IRA contribution.
Third, because Section 125 salary reductions generally reduce wages for FICA purposes, the contribution will also avoid Social Security and Medicare tax. That benefits both the employee and the employer.
That third benefit is what makes the cafeteria-plan route so powerful. It is not merely better than a direct after-tax contribution. It’s also better than a direct employer contribution, because of the payroll tax savings.
The Important Limitation for Employees Under 18
There is one important limitation: the cafeteria-plan salary-reduction option is available only for contributions to an employee’s dependent’s Trump Account, not to the employee’s own Trump Account.
That matters for employees who are age 17 or younger and want to contribute to their own account through payroll. A Section 125 cafeteria plan cannot be used to defer compensation in a way that gives the employee a vested right to receive that compensation in a later year. Because a contribution to the employee’s own Trump Account would effectively be deferred compensation for that employee, it cannot be run through the cafeteria plan.
So the cafeteria-plan strategy is a parent-employee strategy: the employee contributes pretax dollars for a dependent child’s Trump Account.
Watch the Limits
The overall Trump Account contribution limit is generally $5,000 per child per year, excluding contributions from government and charitable donors.
But the employer-program exclusion is more limited. Employer contributions and employee pretax salary-reduction contributions through the employer program are capped at $2,500 per employee per year. Importantly, that limit applies per employee, not per child.
So an employee with three children does not get $2,500 of pretax employer-program contributions for each child. The employee gets a single $2,500 annual cap through the employer program.
Additional direct contributions may still be made up to the child’s overall $5,000 annual limit, but those additional dollars generally will not receive the same upfront pretax treatment. They also create basis that must be tracked.
Roth Conversions at Age 18: The Possible Fourth Benefit
Once the child reaches age 18, the planning should not stop.
Because Trump Accounts move into traditional IRA-style treatment after the child reaches 18, a Roth conversion may become attractive. If the child has low income, it may be possible to convert some of the account to a Roth IRA at a low tax cost, often with no tax at all. Once inside a Roth IRA, future qualified growth can become tax-free.
That is the potential fourth tax benefit: permanent tax-free growth after conversion.
But Roth conversions should be done carefully. The child’s income, dependency status, education credits, scholarships, and kiddie tax exposure can all affect the result. Converting too much in one year may create avoidable tax. A series of smaller conversions during low-income years may be more efficient than one large conversion.
Bottom Line
A Trump Account can be useful no matter how it is funded. Direct contributions can provide tax-deferred growth. Direct employer contributions provide income-tax savings but will still be subject to FICA tax.
The most efficient route may be a pretax salary-reduction contribution through an employer’s Section 125 cafeteria plan to a dependent child’s Trump Account.
That route can combine tax-deferred growth, an upfront income-tax exclusion, and payroll-tax savings. Later, a carefully planned Roth conversion could make permanent tax-free treatment possible.
For families with children, the question should not simply be whether to fund a Trump Account. Remember to also consider how to fund it. If your employer offers a properly designed cafeteria-plan option, that would be a great place to start.