Launching a Bright Financial Future: Tax Benefits for Your Children
Setting up a child's financial future can be one of the most impactful gifts parents, grandparents, relatives, and friends can provide. By leveraging various tax-advantaged accounts and strategies, you can not only contribute to a child’s immediate financial needs but also lay a foundation for lifelong financial security. Here’s a comprehensive look at the options available, including the recently introduced Trump Accounts, Section 529 plans, and other beneficial strategies.
Trump Accounts: A New Tax-Advantaged Tool
Introduction to Trump Accounts - Trump Accounts, established by recent tax reforms, are a novel type of tax-deferred investment vehicle created to encourage savings for children. These accounts can be opened by parents or guardians for children under 18 who are U.S. citizens and have a Social Security number. Contributions can come from various sources, including parents, relatives, employers, non-profit entities, and in some cases the federal government. They are essentially a type of individual retirement account (IRA) but without the requirement that the child have earned income.
Contribution Rules - Annual contributions to Trump Accounts are capped at $5,000 (will be automatically adjusted for inflation). Interestingly, contributions from tax-exempt entities, like foundations, do not count towards this limit, provided they benefit a qualified group of children. It's important to note that no contributions can be made by anyone once the child reaches age 18. Contributions to Trump Accounts are not tax deductible.
Distribution Guidelines - Generally, distributions from a Trump account cannot be made until the account holder turns 18. However, it's worth noting that withdrawals of earnings, but not the original contributions, before the age of 59½ are subject to ordinary income tax and a 10% early distribution penalty unless they qualify for any of many exceptions afforded to IRAs.
Government Contributions: To generate interest in the Trump Accounts Congress created a pilot program wherein the federal government contributes $1,000 into the account of every eligible newborn child. This contribution is for U.S. citizens born between January 1, 2025, and December 31, 2028. The contribution is treated as if the child made a $1,000 payment against their income tax, with the amount getting credited back to their Trump Account. This automatic initiative is designed to kick-start savings and investment for the child's future, encouraging early financial planning and helping families build a foundation for long-term financial growth. Additionally, if the account is not opened by the time the first tax return is filed where the child is claimed as a qualifying child dependent, the Secretary of the Treasury will establish the account on the child's behalf, ensuring that no eligible child misses out on this benefit.
Timing – It is anticipated that parents (and others) will be able to make the first contributions to Trump Accounts in mid-year 2026. Watch for more details as the government works out the logistics of these new accounts, such as how to establish a Trump Account, over the next few months.
Section 529 Plans: Time-Tested Education Savings
What is a 529 Plan? A Section 529 plan is a tax-advantaged savings account specifically designed to save for education expenses. It provides a platform to accumulate funds that grow tax-deferred and can be withdrawn tax-free when used for qualified education expenses.
Contributions and Gift Tax Considerations:
o Who can contribute? Parents, grandparents, and even family friends can contribute to a 529 plan on behalf of a child. There are no income restrictions on who can open or contribute to these plans.
o Annual Contribution Limits: To avoid gift tax implications, contributions should remain within the annual gift tax exclusion limits, $19,000 per beneficiary (as of 2025) for single filers and $38,000 for married couples.
o 5-Year Lumping Strategy: Contributors can front-load the account by making five years' worth of contributions at once. This strategy allows up to $95,000 (or $190,000 for married couples) per beneficiary without incurring gift taxes, assuming no other gifts are made during the five years.
Additionally, if the annual gift tax exclusion increases during this five-year period, contributors have the flexibility to make makeup contributions, aligning with the new exclusion limits, and further enhancing the potential investment into the child’s future education savings.
o Uses and Flexibility: Funds from a 529 plan can be used for a variety of education-related expenses, including tuition, fees, books, and even room and board when attending college. Recent law changes have expanded the allowable use of 529 plan funds to include up to $20,000 ($10,000 if paid before July 4, 2025) per year for K-12 tuition and related expenses. Costs of certain apprenticeship programs are also eligible. If the original beneficiary doesn’t need the funds, the account owner can change the beneficiary to another family member.
o Rollover Opportunities: In situations where the funds in a 529 plan exceed educational needs, the Secure Act 2.0 allows rollovers of up to $35,000 from a 529 plan to a Roth IRA for the beneficiary, provided the 529 has been open for at least 15 years. This option ensures that the savings are not wasted and continue to benefit the recipient’s financial health.
Employing a Child in Family Business: The Benefits: Engaging a child in meaningful work within a family business or elsewhere not only instills a strong work ethic but also presents various tax advantages.
Income Tax Benefits:
o Reasonable Compensation: For employing a child in a parent's business, the child can earn up to the standard deduction amount tax-free. For 2025, this is $15,750, meaning the child doesn’t have to pay federal income tax on earnings below this threshold.
o Business Deductions: The wages paid to children can be deducted as a business expense, which helps reduce the taxable income of the business and potentially lowers overall tax liability. Additionally, if the parent's business is not incorporated—meaning it operates as a sole proprietorship or a partnership where both partners are the child's parents—the wages paid to the child are not subject to FICA taxes (Social Security and Medicare taxes) if the child is under the age of 18, providing an added tax advantage by lowering employment tax expenses.Retirement Account Contributions: A child's earned income opens the door to funding a retirement account early.
o Roth IRA: If they have earned income, children can contribute to a Roth IRA, up to the lesser of their earned income or the annual contribution limit ($7,000 for 2025). The contributions grow tax-free, and withdrawals in retirement are also tax-free, providing a significant financial advantage.
A Roth IRA is often considered an excellent choice for children with minimal taxable income due to several unique features and benefits:
§ Tax-Free Growth: Contributions to a Roth IRA are made with after-tax dollars, and the investments grow tax-free. Given that children are likely in the lowest tax bracket, the tax-free growth aspect is highly beneficial over the long term.
§ Tax-Free Withdrawals in Retirement: Qualified withdrawals from a Roth IRA are tax-free, which means that both the contributions and the substantial growth that can occur over decades are not taxed upon withdrawal, maximizing the money available in retirement.
§ Flexibility: Contributions (but not earnings) to a Roth IRA can be withdrawn at any time for any reason without penalty or taxes. This accessibility makes it a flexible option if the child needs the money for unplanned expenses.
§ Maximizing the Power of Compounding: Starting a Roth IRA early gives the investments more time to benefit from compound interest. Even small contributions can grow significantly over a long period, creating a sizable nest egg for retirement.
§ No Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRAs do not require minimum distributions during the account holder’s lifetime. This allows funds to potentially grow untouched or be passed on to heirs.
§ Earning Income Requirement: Opening a Roth IRA for a child requires that the child have earned income. Encouraging children to earn and contribute to their own retirement funds can instill a savings habit and financial responsibility early on.
These features make the Roth IRA an appealing option to begin a child’s journey toward financial independence and retirement savings, especially when their income is low and the tax impact is minimal.
Additional Strategies: Other Financial Boosts
Saving for Retirement Early: Even minors are eligible to have a Roth IRA if they have earned income.
Teaching Financial Responsibility: Encouraging savings habits early, whether through structured accounts like a Trump Account and 529 plans or personal savings programs, fosters lifelong financial discipline.
Encouraging Entrepreneurial Ventures: If your child shows interest in launching their own small business or providing services, such as tutoring or dog walking, this experience can also lead to early financial growth, teach important money management skills, and generate income that can fund savings or retirement accounts.
Conclusion: The array of financial vehicles available today, from Trump Accounts to 529 plans and beyond, offer a robust toolkit for shaping a child’s financial future. These options not only help in covering educational and immediate expenses but also build a financial framework that supports investment acumen and retirement savings. By taking full advantage of these tools, those eager to support a child’s financial journey can effectively set them on the right foot for a prosperous future. Whether it's starting a savings account, employing them in a family business, a summer job, or ensuring their education is funded, these strategies cement a legacy of financial security and prudence that will benefit future generations.
If you have questions related to any of these tax benefits, please contact this office.
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