How Trump Accounts Could Make Americans Worse Off

Westin: This is a story about the miracle of compounding. As Benjamin Franklin's popular saying goes, "a penny saved is a penny earned." And Einstein added to it that compounding is the most powerful force in the universe. But for that force to work there have to be those pennies saved. And, unfortunately, today Americans are saving less and borrowing more. Now governments are stepping in to jumpstart savings programs starting as soon as children are born. Our colleague Scarlet Fu brings the story from inside America's wallets on the growing options to save more and smarter. -I think I got 3 new puzzles today. -When Wendy Robinson's children were born, she was in her 30s, still paying off her student loans and juggling the many costs of being a young parent. -For a good chunk of when my kids were little, our costs for child care were more expensive than our costs for our mortgage. -Then came the 2008 financial crisis, a shock that left Robinson and many more Americans deeply in debt. -Our family had the misfortune to buy a house in Arizona in 2006, which turns out to be about the worst time to have ever bought a house. -When Robinson finally began putting money aside for her son's educational savings fund, she knew she was running out of time. -It was just realizing, "Oh, we've only got like 6 years," because my son was already in middle school by that point. -This summer the Trump administration launched a new savings program that might have helped parents like Robinson, letting families and friends put money into a fund for babies from the day they are born with a 1000 dollar gift from the government to get them started. It's an idea that National Economic Council director Kevin Hassett has been interested in since the 1990s. -Very very few Americans have benefited from the massive compounding from equity markets and other forms of capital investment. But we need to have an account so that when a kid's born, they can sort of see that they're part of the American dream too. And the compounding can help make their life better. -Today Hassett's idea is realized in the form of Trump Accounts. The latest offering in a patchwork of federal savings accounts available to families, each with its own rules and tax treatments. -So I think the best way to explain a Trump Account is that it's an early way to save for retirement. -Tricia Scarlata is head of education savings at JPMorgan, where she manages strategy for the 529 college savings plan. -So I think with Trump Accounts that's even encouraging families even at a younger age to start thinking about their child's financial future. And I think the ultimate goal in everything that we do, you know, is to try to prepare people as early as possible, so that we eliminate this long term debt. Student loan debt today is at $1.65 trillion. Credit card debt is $1.2 trillion. It's a real problem. -Saving those pennies early and letting compound interest grow is a good start, particularly with a seed grant from the government. But the net results available to the child later in life also matter especially when you factor in taxes. Both 529s and Roth IRAs have their advantages come tax season because qualified withdrawals including all investment gains come out completely tax free. Trump Accounts will work differently with earnings taxes ordinary income when the child is qualified to start withdrawing the money at 18. That means families don't get the same tax-free growth as a 529 and Roth IRA. Adam Michel studies tax policy at the Cato Institute and he says that could be a problem. -The Trump Account is this account that's put on top of the existing savings ecosystem. But it isn't a simplification. They have their sort of seed history in universal savings accounts. This idea that we have one universal, one-stop shop for individual savings where you can put your own money in. It grows tax free, and then you can use it for whatever you want and whenever you want without any strings attached. The Trump Account, because of the political process and the constraints in the big bill that it was part of, got contorted in that Congress wanted to add this this baby subsidy into the mix which then, when you start putting government money into the accounts, requires a bunch of new strings to be attached, so that people don't just take the money out immediately. The underrated piece of Trump Accounts is that to the extent that a less sophisticated family chooses to put their money in a Trump Account instead of somewhere else, you could be actively making those kids worse off if the dollar in the Trump Account faces higher taxes than where it otherwise would have gone. -So if a family has only one additional dollar to put into savings, where would it go the furthest? So with any client we say, what is your objective? If you are really looking to plan for your child's future and what they're going to do in terms of college or perhaps vocational school or something like that, a 529 plan one hundred percent makes the most sense because again you're putting in after tax dollars, it's growing tax-free and it's coming out tax-free. -The Trump Accounts work at the federal level. At the state level, Connecticut devised its own plan that gives children a jumpstart when they're born by contributing $3,200 to buy a so-called baby bond for the child. But there's a big difference. While the Trump Accounts are for all children, Connecticut's baby bonds are only available to those covered by the state's Medicaid system, inserting a redistribution factor into the equation. Erick Russell is the Connecticut State Treasurer. -The goal of the program is just very different than what we've seen out of the Trump Accounts. This program is designed to address wealth inequality in a long-term, big-picture way here in Connecticut. It is a program that is set right now to run at least 12 years, but our plan is to run that program in perpetuity. -Do you expect the savings and baby bonds to supplement existing assistance programs or perhaps even one day replace existing assistance programs? -So ideally we have people who are moving up out of poverty, and I think that was one key piece to getting support for this program, is we can look at an investment and say we can use resources to help sustain people who are living in poverty, or we can take resources and make an investment to help people lift out and not need to be on some of these programs or need that state assistance. -While Connecticut's baby bonds are designed with the explicit goal of addressing the wealth gap, Michel of the CATO Institute says Trump Accounts might have the opposite effect. -The way Trump Accounts are structured, because there are penalties on withdrawing the money before retirement and complex rules on what the money could be used for, families or children, when they turn 18 and get access to these funds that have the resources to help folks bridge to adulthood, will keep the money in the account and let it grow over time, where kids that are maybe from families with less means will face more pressure to take the money out, pay the government penalty, pay the higher taxes, and lose out on that growth over time. So if these rules aren't changed over the next decade or so, I think these accounts could actually make wealth inequality worse, not better. -Connecticut estimates that a $3,200 baby bond will grow to somewhere between $11,000 to $25,000 by the time the child is allowed to withdraw the funds between the ages of 18 and 30. On any given day, Russell is on the road talking to students and families about how he's managing the state's money. We joined him at Southern Connecticut University in New Haven, where he spoke with students in a Connecticut politics class. -I'm essentially the elected CFO of the state, right? And so I've managed all of the state's finances. -How did you come to this decision that baby bonds was the right move? Because it's going to be a long time before you see the benefit of this. -In this role, thinking about building a future economy, that requires investment, and that some of those long-term investments make sense. -As of this month, the Treasury Department announced that children under age 18 will be automatically enrolled in Trump Accounts, adding more than 60 million children to that program. -There are over 50,000 children that have been born eligible... -Russell says auto-enrollment is key to the design of any of these savings programs, including Connecticut's baby bonds. -Well, I think it's critical. Folks that you are most looking to connect with, people who probably could benefit most from a program like this, are the most likely to fall through the cracks, right? -So while automatic enrollment for Connecticut's baby bonds and the Trump Account is a crucial step one, understanding the tax treatment of any savings program is just as important. What's the biggest missed opportunity when it comes to saving for the future? -So I think a lot of families aren't taking advantage of tax-friendly vehicles. In the 529 space, you have 70% of families that are saving for college. Half of those families are sitting in cash. -What has this 529 product and its various iterations taught you about how to design a savings program that people will actually understand and actively use? -I would say the biggest thing I think the plan should do more proactively is automatic contributions, because it's tough to get somebody to invest. But what we find is only about 35% of people automatically invest every month. So that's the key, is not just start early, save often. So it's start early, save often, but don't just save, invest. -Watching your initial investment compound may seem like magic, but the reality of saving involves discipline and consistency. Once Robinson began actively saving for her two children's education, she targeted putting $500 in each of their 529 accounts every month. Her goal? Contribute $15,000 annually towards her son's college expenses. Today, her son is a freshman at the University of Minnesota, and merit scholarships mean she won't even have to tap the account for at least the first year. -When he started college, he had a healthy savings account of his own as well. And so I think that... I think... I think that was really good, because I think he feels more confident, certainly, managing his money as a college student than I did. -For Robinson, making a difference for her family started with talking with the kids about money and emphasizing the discipline of saving and the miracle of compounding so the next generation can experience it for themselves.