Between custodial accounts, Roth IRAs for kids, 529 plans, and now proposed “Trump accounts,” parents have more ways than ever to save for their children. More choice sounds good — until tax rules start colliding.
The biggest mistakes in this area aren’t about picking the “wrong” account. They’re about misunderstanding how ownership, earned income, unearned income, and kiddie tax interact over time — especially as kids grow, file their own returns, and become eligible for Roth strategies.
Each of these accounts serves a different purpose — and misunderstanding how they interact with ownership rules and kiddie tax is where planning often goes sideways.
A custodial account (UTMA/UGMA) is a taxable account opened for a minor, managed by an adult custodian, but legally owned by the child. That ownership is why investment income can trigger kiddie tax rules — and why planning around timing, gains, and future conversions matters more than most families expect.
“Trump accounts” are a newly proposed structure designed to encourage long-term savings for children by combining elements of custodial accounts and retirement-style tax treatment.
A 529 plan is a tax-advantaged savings account designed for education expenses, where contributions grow tax-deferred, and withdrawals are tax-free when used for qualified education costs.
A Roth IRA for a child is a retirement account funded with earned income, where contributions are made after tax, growth is tax-free, and qualified withdrawals in retirement are not taxed. A Traditional IRA for a child is similar, but contributions may be pre-tax, growth is tax-deferred, and withdrawals are taxed as ordinary income.
Our goal here is to outline a practical summary of the nuances that tend to get missed, specifically with custodial accounts and Trump Accounts.
Kids Can (and Often Should) Have Multiple Account Types
If a child has earned income, they are not limited to choosing either a taxable account or an IRA.
They can have both:
- A taxable account for flexibility and long‑term capital gains treatment, also known as a custodial account or UTMA/UGMA.
- A Traditional IRA or Roth IRA, funded up to their earned income limit (A Roth IRA is almost always preferred).
Key takeaway:
If there is earned income, do both when appropriate – different buckets, different tax advantages.
This flexibility matters later — especially when navigating kiddie tax thresholds and future Roth strategies.
Stay On Top of Kiddie Tax Rules for UTMAs (2026 Thresholds)
Custodial (UTMA/UGMA) accounts often look simple — until unearned income shows up.
For 2026, the kiddie tax works in three buckets:
- First $1,350 of unearned income → tax‑free.
- Next $1,350 → taxed at the child’s marginal rate.
- Anything above $2,700 → taxed at the parents’ marginal rate.
This is where planning becomes proactive instead of reactive.
A Planning Question Worth Asking
Should you be resetting the cost basis in existing UTMAs?
Strategic realization of gains (within the first two buckets) can reduce future tax drag — especially before income pushes the child into the parents’ bracket.
Ignoring this often means paying unnecessarily high taxes later.
Trump Accounts: Qualifying for the $1,000 Pilot Contribution
A common point of confusion:
- The $1,000 pilot contribution requires a separate election form (Form 4547) and only applies to children born between 2025 – 2028.
- It receives pre‑tax treatment.
- It does not count toward the annual $5,000 contribution limit.
That makes it powerful — but only if you complete the paperwork correctly.
Miss the election, and you lose the intended benefit.
Trump Accounts: The Importance of Form 8606 (File It Forever)
Form 8606 is not optional administrative fluff. Trump Accounts (TA) can contain a mix of pre-tax and after-tax dollars.
- Direct contributions, which are non-deductible, are treated as after-tax dollars (i.e., basis) within the TA.
- Employer contributions, qualified general contributions (donations, e.g., Dell Foundation), and the $1,000 pilot program contribution – all of which are excluded from gross income when received – are pre-tax.
- Additionally, any growth or investment income beyond the initial contributions, which is tax-deferred until withdrawal, is pre-tax within the account.
Form 8606 is the only permanent record of after‑tax basis in an IRA. Said another way, this is maintained so that your direct contributions aren’t taxed twice.
Why this matters even more for kids:
- Records get lost over time.
- Parents file returns initially, but kids eventually file on their own.
- The IRS does not reliably track this for you.
Best practice:
- File Form 8606 every single year it applies
- Keep copies indefinitely — even in years with no contributions
Think of it as a legal proof document, not a tax form.
Trump Accounts: The Roth Conversion Assumption Trap
A common assumption:
“We’ll just convert it to Roth when our child turns 18 and his/her tax rate is low.”
That logic breaks down under kiddie tax rules.
Why This Is Risky
- A Roth conversion is treated as unearned income.
- Unearned income is subject to the kiddie tax.
- Large conversions can be taxed at the parents’ marginal rate.
This often means:
- Waiting until the parent no longer claims their child on their tax return.
- Using partial conversions instead of all‑at‑once moves.
- Timing conversions for years when the child has no earned income, allowing more income to fall into the lower kiddie tax buckets (and likely utilizing the partial conversion strategy above).
Roth conversions are not automatically “cheap” just because the account owner is young.
Trump Accounts: How to Withhold on a Roth Conversion
Another easy‑to‑miss rule:
- If you withhold taxes on a Roth conversion, the amount withheld is treated as a distribution.
- For a minor, that distribution is typically subject to a 10% penalty.
Best practice:
Taxes on a conversion should come from outside funds, not from the IRA itself.
This rule applies to adults, too — but it’s especially damaging when balances are small and compounding time is long.
Trump Accounts: A Hidden Financial Aid Advantage
One surprising upside:
- A Trump Account is structured as a retirement account. As a result, financial aid calculations exclude it!
That can materially improve aid eligibility compared to assets counted under student ownership formulas.
Account structure matters — not just for taxes, but for future optionality.
Final Thoughts
When it comes to kids and money, the biggest mistakes aren’t about being too aggressive.
They’re assumptive:
- Assuming Roth conversions are always low‑tax.
- Assuming the IRS keeps track of the basis.
- Assuming custodial accounts are “simple.”
Good planning here isn’t about optimization for one year.
It’s about keeping future doors open — and avoiding rules that quietly close them.
If you’re setting up or managing accounts for kids, this is one area where getting the details right early pays off for decades. Connect with us today to discuss how we can optimize your kids’ investment strategy.
Please consult with your financial advisor and/or tax professional to determine the suitability of these strategies. All views, expressions, and opinions in this communication are subject to change. This communication is not an offer or solicitation to buy, hold, or sell any financial instrument or investment advisory services.