Trump Accounts may complicate college financial aid calculations

More than 6 million U.S. children have been enrolled in Trump Accounts since their July 4 launch, according to the U.S. Department of the Treasury, putting a new tax-deferred savings vehicle into future college-aid calculations. Bank of New York Mellon, which the Treasury Department said is managing the initial accounts, reported $50 million in direct deposits and gifts from relatives and friends in the days after launch.

The accounts, also known as 530A accounts, are designed mainly for long-term retirement saving for children. Funds can be withdrawn without penalty at age 18 to pay higher education costs, but families may need to weigh how balances and withdrawals are treated under the Free Application for Federal Student Aid.

How FAFSA could count the accounts

The FAFSA uses the Student Aid Index to estimate what a family can contribute toward college. That formula includes income and assets held by parents and students, including savings and investment accounts. Student-owned assets generally receive harsher treatment than parent-owned assets because the formula assumes students can contribute more of their own resources toward education.

Higher education expert Mark Kantrowitz said a Trump Account would be reported as a student asset on the FAFSA. If the account is treated as an investment account, he said, need-based aid eligibility could fall by 20% of the account value. Under that treatment, a $10,000 balance could reduce need-based grants by as much as $2,000.

The potential effect could apply even where families make no additional deposits. The accounts include a one-time $1,000 pilot contribution from the Treasury Department for children born from 2025 through 2028, subject to eligibility. Kantrowitz said the structure means the government may provide funds while reducing aid eligibility through the financial-aid formula.

Kalman Chany, a financial aid consultant and author of the Princeton Review’s “Paying for College,” described another possible treatment. He said the accounts could be subject to IRA-like rules after the growth period ends. Once an account holder turns 18, traditional IRA rules apply, and Chany said funds in IRAs and other retirement accounts are not currently reported as FAFSA assets.

The Department of Education has not yet issued official instructions on how Trump Accounts should be reported on the FAFSA. Chany said eligible families would still have a reason to claim the $1,000 government seed deposit, because in a worst-case outcome the loss of aid would not exceed the value of the seed-funded account.

Withdrawals may affect future aid

Students using the accounts for college may also face tax and aid consequences. Treasury Department guidance says withdrawn earnings are taxed as ordinary income. Student income can affect aid in later years: the FAFSA shields some student income, but amounts above the protected level can be assessed at up to 50%.

Chany said timing may matter because financial-aid awards rely on tax information from the “prior-prior year,” meaning income from two years earlier. He said a student who waits until after Jan. 1 of sophomore year to take a distribution may keep that income out of later aid calculations.

How 529 plans compare

Parent-owned 529 college savings plans receive more favorable FAFSA treatment than student-owned assets. Up to 5.64% of parental assets are counted under the formula, compared with 20% for student assets.

Withdrawals from a 529 plan are tax-free when used for qualified education expenses, according to IRS rules. Trump Account distributions may be partly taxable because the accounts can include both pretax and after-tax contributions.

Annual Trump Account contributions are capped at $5,000 per child. By comparison, individuals can gift up to $19,000 per child this year without using lifetime gift tax exemption amounts, and grandparent-owned 529 plans can be funded without affecting a grandchild’s FAFSA eligibility under current rules.

This story draws on original reporting from CNBC.