Incredibly Dumb & Extremely Sad

It hurts my brain to write about T**** Accounts, but as every new parent will have one, I believe that I must.

In a legislative act filled with abominations, the creation of T*** Accounts is certainly not the worst. They are not evil. They are simply and deeply dumb. I was going to say profoundly dumb, but someone might mistake that to mean that there was a thought process, however flawed, behind their creation. As near as I can tell, there was not.

Here’s how they work. Every baby born from January 1, 2025 to December 31, 2028 — regardless of their parents’ wealth and that’s a thing right there — will have a one-time $1000 deposit in a securities account in their name, courtesy of the US Treasury. From there, parents (or others) can contribute up to $5000 per year (adjusted annually for inflation) should they wish to do so. When the child turns 18, the account becomes theirs.

So, what’s my beef? Aside from the complete lack of means testing, that is? Well, this seemingly noble idea, aside from the opening deposit, simply does not function as well as multiple other investing-for-your-child options that are easily available to you.

Let’s start with how the money must be invested. Per the law, it must be invested in a low-cost US stock index fund. Now that sounds reasonable enough (it would likely be my choice anyway), but then again, why is the type of investment asset being mandated? If I am going to use it for college and I am now in high school, maybe I don’t want to still be 100% invested in the market. What about exposure to non-US global markets? Diversification anyone? Maybe I’m a scaredy cat and I want a bit of bonds to manage the volatility. Provide a default investment option, sure. But removing all choice? After all, the bulk of the funds in the account if later deposits are made will be my money.

What does “low-cost” mean in this context? According to the legislation, the maximum index fund expense ratio would be 0.1%. Which sounds awfully good until you realize that Vanguard’s Total Stock Market ETF has an expense ratio of 0.03%. If I am an investment firm tasked with administering millions of these wee little accounts, do you believe that I am going to charge even a penny less than the maximum? (Will there be other plan administration fees?) In dollars and cents, the difference in fees to investors is pretty trivial if one never contributes another dime to the account on their own. Even if you use the account as intended, adding $5000 per year, the difference is not mind-blowing.[1] However, there were 3.6 million babies born in the US last year; for the yet-to-be-selected fund companies, this is a nice little gravy train.

Alright, so your child turns 18. Now what happens? Essentially it turns into a traditional IRA. If they use the funds for a qualified expense (buying a first home, education, medical expense, starting a business), they can withdraw money without penalty. Taxes, on the other hand, are a different story. Contributions, should there have been any (which are not tax deductible, by the way), are withdrawn tax-free, but earnings are taxed at the ordinary income tax rate. So already we are in a worse position than using a 529 account, a Roth account or possibly even a plain old taxable brokerage account. If your child wants the cash before retirement age and does not use it for any of the aforementioned purposes, then an additional 10% penalty applies.

It’s pretty clear that the primary audience for these accounts is people who are unaware of alternatives with more attractive terms, such as a 529 account for educational expenses, a Roth account when your child begins to earn income, or simply investing in a non-tax advantaged account with lower fees and without any restrictions on investment choices or withdrawals. My prediction is that most of these accounts will remain dormant for years. Those “in the know” will make a different choice, and those without the means to invest more, won’t.

There is also the rather important issue of whether these accounts will be considered an asset in terms of determining a household’s eligibility for needs-based assistance such as SNAP.

Who benefits from T**** Accounts (other than investment companies)? High net worth/high marginal tax bracket households that have maxed out every other tax-advantaged savings option and are looking to shelter just a bit more income from taxes because, well, why not?

Finally, as you will surely ask, how does a T**** Account compare to so-called Baby Bonds? Available in a few states, the most recent federal proposal was called the American Opportunity Accounts Act (AOAA). It starts with a $1000 deposit from the Treasury for every child…but then adds up to $2000 per year until the child is 18 for households with poverty-level income. Wealthier households would receive less annually, and households at 500% of the poverty line would not receive additional deposits at all. (Right now, for a family of four, the poverty line is $32,150.) So already this is an improvement over T**** Accounts as it is squarely focused on those who actually need it, and it results in a meaningful amount of funds at age 18 for households that cannot afford to save.

The intended uses for the accounts are the same (education expenses, home buying, starting a business, retirement) however under AOAA, distributions are always tax-free. In the last version of the federal legislation, there was no ability to take a non-qualified distribution, therefore no provision for the usual 10% penalty.

 T**** Accounts and the AOAA proposal also diverge in a very important way in how the investment is managed. Under AOAA, funds would be pooled and invested as one. This is much more cost effective than creating millions of itty bitty individually held and managed accounts.

So here we are. Should you welcome a T**** Account (despite the name) for your newborn? Sure, it’s literally free money. But is it really? The estimated cost to taxpayers is about $3 billion a year for the initial $1000 deposit. And of course, the ongoing subsidy to high income households sheltering their $5000 per year per child in a tax deferred haven. As with any budget line item, you must compare it to what could have been. Perhaps healthcare to ensure that newborns make it to their 18th birthday intact. Or childcare so that their parents can earn more. Or more affordable education. Or any number of other uses that would better meet the needs of families who really need assistance to build wealth. The sadness of what might have been…

At the end of the day, the T**** Account is an expensive gimmick. But perhaps come 2029, it will get (in addition to new branding) a fundamental re-think that will transform it into a truly useful tool for building wealth.

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[1] If you added $5000 per year for 17 years and earned a 7% rate of return, you would pay about $1960 in fees. But if you used the aforementioned “regular” fund, you would pay only $591 in fees.