Trump accounts grow tax-free while the money stays in the account

A Trump account (formally called a Coverdell Education Savings Account or ESA) allows the money you deposit and the earnings it generates to grow without federal income tax as long as the funds remain in the account. You do not pay tax on interest, dividends, or investment gains each year the way you would in a regular savings or brokerage account. The tax break applies only to the growth itself—not to the money you put in, which comes from after-tax dollars.

The tax-free growth stops when you withdraw the money. At that point, the earnings portion becomes taxable to whoever receives it. The original deposits you made are never taxed again, since they were already taxed before you put them in.

Key Takeaways

  • Money in a Trump account grows without federal income tax each year, but only if you use it for may have access to education expenses.
  • When you withdraw earnings for education costs, those earnings are not taxed—but earnings withdrawn for any other reason are taxed as income to the beneficiary.
  • If the account holds more money than needed for education, the excess earnings face both income tax and a 10 percent penalty when withdrawn.
  • The tax-free status depends on using the money for tuition, fees, books, room and board, and other costs the IRS defines as may have access to education expenses.
  • State tax treatment varies: some states offer additional state income tax breaks, while others do not.

What counts as a may have access to education expense

The tax-free growth only protects you from federal tax if you withdraw the money to pay for may have access to education expenses. These include tuition and fees at any accredited college, university, or vocational school; books and supplies; computers and equipment; and room and board if the student is enrolled at least half-time. The school must be may be able to access to participate in federal student aid programs.

The definition also covers K-12 tuition at public, private, or religious schools (up to $35,000 per year as of 2024, though this limit may change). Starting in 2024, you can also roll unused Trump account funds into a Roth IRA without tax consequences, which creates a new way to use the account if education plans change.

Expenses that do not may have access to include room and board for students attending school less than half-time, student loan repayment, tutoring, test prep courses, and transportation. If you withdraw money for these purposes, the earnings portion is taxed as ordinary income plus a 10 percent penalty.

How the tax-free growth actually works in practice

Suppose you open a Trump account for a child and deposit $2,500. You invest it in a mutual fund that earns $300 in the first year. That $300 is not reported on your tax return, and you owe no federal tax on it. The next year, the account balance is $2,800, and it earns another $350. Again, no tax is owed that year. This continues year after year until you withdraw money.

The tax deferral is automatic—you do not file any special forms or claim any credits to get it. The account custodian (usually a bank or investment firm) handles the accounting. However, you do need to file a Form 1099-Q when you make a withdrawal, and you must track which portion of the withdrawal is original deposits (never taxed again) and which portion is earnings (taxed if not used for education).

What happens when you withdraw for education

When you withdraw money to pay for may have access to education expenses, the earnings portion comes out tax-free. You still file Form 1099-Q to report the withdrawal, but you also file Form 8863 (Education Credits) or another education tax form to show that the withdrawal was for may have access to expenses. The IRS then excludes the earnings from your taxable income.

The timing of the withdrawal matters. The expense must occur in the same calendar year as the withdrawal, or in the first month of the following year. If you withdraw $5,000 in December for spring semester tuition, that counts. If you withdraw in December but do not use the money until the following September, the earnings may be taxable.

Penalties and taxes on non-may have access to withdrawals

If you withdraw money for anything other than a may have access to education expense, the earnings portion is taxed as ordinary income to the beneficiary, plus a 10 percent penalty. The original deposits come out tax-free and penalty-free. So if your account holds $3,000 in deposits and $500 in earnings, and you withdraw $2,000 for a non-may have access to expense, roughly $333 of that is earnings and subject to tax and penalty.

The 10 percent penalty is steep and applies to the earnings only, not the full withdrawal. This is why it matters to plan withdrawals carefully. If the beneficiary graduates and has leftover money, you have options: roll it to a Roth IRA (as of 2024), transfer it to another family member's Trump account, or withdraw it and pay the tax and penalty.

State tax treatment varies by location

Federal tax law is the same everywhere, but state tax treatment differs. Some states offer a state income tax deduction for Trump account contributions, meaning you can reduce your state taxable income by the amount you deposit. Other states offer no state tax break at all. A few states tax the earnings each year even though federal law does not.

Before opening an account, check your state's rules. If your state offers a deduction, it can make the account more valuable. If your state taxes the earnings annually, the federal tax-free growth is partially offset. Your account custodian or your state's tax authority can tell you which applies where you live.

How Trump accounts compare to other education savings vehicles

A 529 plan (also called a may have access to tuition plan) works similarly—money grows tax-free and withdrawals for education are not taxed. However, 529 plans allow much larger contributions (often $235,000 or more per beneficiary, depending on the state), while Trump accounts cap out at $2,000 per year per beneficiary. Trump accounts also allow investment in any mutual fund or stock, while 529 plans limit you to the investment options the plan offers.

A regular savings account or brokerage account has no contribution limit, but you pay federal tax on the earnings every year. A Roth IRA is not designed for education but offers tax-free growth; money withdrawn for education before age 59½ avoids the early withdrawal penalty (though earnings are still taxed unless certain conditions are met).

Frequently Asked Questions

Do I pay tax on the money I deposit into a Trump account?

No. You deposit after-tax dollars (money you have already paid income tax on), and you do not get a federal deduction for the deposit. Some states offer a state income tax deduction, but federal tax does not. The deposits themselves are never taxed again.

What if I withdraw money and do not use it for education in the same year?

The earnings portion becomes taxable as ordinary income to the beneficiary, plus a 10 percent penalty. The original deposits come out tax-free. If you withdraw in December but do not spend the money until the following year, the earnings are generally treated as non-may have access to.

Can I move money from a Trump account to a 529 plan?

No direct rollover exists between the two. However, as of 2024, you can roll unused Trump account funds into a Roth IRA for the same beneficiary without tax or penalty, which provides an alternative if education plans change.

Does the tax-free growth explore if the beneficiary gets a scholarship?

Scholarships do not automatically disqualify the account. However, if you withdraw money in the same year the beneficiary receives a scholarship, you may owe tax and penalty on the earnings to the extent the withdrawal exceeds the education expenses not covered by the scholarship. Coordinate timing carefully if a scholarship is involved.

What if the beneficiary does not go to college?

You can roll the account into a Roth IRA for the same beneficiary (as of 2024), transfer the funds to another family member's Trump account, or withdraw the money and pay income tax plus a 10 percent penalty on the earnings. There is no tax or penalty on the original deposits.