Many parents want to give their children a great financial start as they worry about their financial future in fact “62% of parents believe their kids will be financially worse off than they are”*
They would like the option to be able to help their children in the future with things like their education costs or a house deposit.
But once parents start looking at this it can become a little overwhelming as there are lots of investment options and different tax considerations.
In this article I break down what you need to consider when investing for your children including:
- What Assets Should I Invest In – Cash, Shares of Property &
- Who Should Own These Assets – Child Name, One Parent/ Both Parents or a Bond?
What Asset Should You Invest In: Cash, Shares or Property?
Let’s say for simplicity you want to invest in cash. If this is your preferred option, then you could look for a high interest bank account that has low to no fees. Websites like Finder.com can help you find and compare these accounts. Currently on these sorts of bank accounts you may be able to earn 3% if you are lucky – but depending on whose name this it owned by you may also have to pay tax on what you earn. Which means that you don’t really earn 3%.
If you want to invest in cash then another option you have is to put it off your mortgage. This way whatever your mortgage interest rate is (e.g. 4-5%) you are effectively earning and bonus this is tax free.
An alternative is to use an offset account. An offset account is a bank account where what- ever money sits in it offsets your home loan. Example if you had a mortgage of $500,000 and you had $10,000 in your offset account then you only have to pay interest on the difference in this case $490,000.
I am a fan of the strategy of using offset accounts as you can more easily see and access the money. But sometimes loans with features like offset accounts have a higher interest rate so you just need to determine whether it’s worth it or not.
Over the long term shares (especially if you hold a diversified portfolio) tend to perform better then cash and often unlike cash keep ahead of inflation.
Inflation is when the cost of things increase and your money therefore buys less eg think about when you were a kid you could get a bag of lollies for 20 cents now compare that to what you could buy with 20 cents today. If your money isn’t growing by more than what the cost of living is rising by then your money is going backwards even if it doesn’t look like it on the bank statement.
If you are interested in investing and have the time dedicated to learning you may want to
DIY and set up a trading account to buy:
- Shares – if you have a small balance then shares may not provide you with the diversification you need. Picking one share can be risky because something could happen to that company or industry.
- Listed Invested Company – own shares in other companies who do the investing for you. Effectively you buy shares in the company and get an interest in their portfolio. This can be a great way to get diversification and they can be actively managed.
- Exchange Traded Fund (ETF ie index that trades on the stock exhange) – these are not actively managed and tracks index or market. You get the same return as the market/index. You can have indexes that track lots of different things eg ASX 200, gold, telecom etc. Some people argue that an index such as one that tracks the top 200 shares in Australia (ASX 200) gives you great diversification as you get exposure to the top 200 shares in Australia. Others suggest that sometimes it’s not really that diversified as markets can have a heavy weight to one asset class or industry eg on the ASX 200 financials make up over 32%**
Generally each trade costs you between $20-$30 and most trading accounts have a minimum trade of only $500 – which if the trade cost was $20 is 4% of the balance (It’s a lot of work your money has to do to make that back). Which is why I generally would only buy $2,000 at a time which if the trade costs $20 is 1%.
Using a Managed Fund
Alternatively, if you don’t have time or desire to manage shares yourself then you can look to use a managed fund. In a managed fund, your money is pooled together with other investors.
An investment manager then buys and sells shares or other assets on your behalf ie they can be active in their investment approach. The idea is that with a team of experts actively reviewing this should out perform. You also get administration services like tax and performance reports which can save you time. Critics argue that management fees can often offset performance. But with new technology management fees have been decreasing significantly making managed funds more attractive.
Just in case it’s not confusing enough you can also have an indexed managed fund (similar concept to ETF above). Generally if you are wanting to invest smaller amounts regularly then an indexed managed fund can be preferred as you don’t have to pay brokerage each time.
When we work with clients we often combine active management and passive/index style management which we have found particularly beneficial combination in a volatile market.
You may also find managed fund offer better reporting (both for performance and tax records)
You could look at investment property as a potential investment option. The downside is this may require a larger initial amount to get started with investing as generally you need a 20% deposit.
Also a lot of properties are negatively geared. This is where it costs you more (eg loan interest, rates, insurances etc) then you receive in rent.
With negative gearing you make a loss each year but you get to claim that loss a tax deduction.
Remember a tax deduction doesn’t mean you get the whole loss back just the tax at your marginal tax rate (the more you earn and the higher your tax rate the better this strategy works).
But you also get to claim depreciation (wear and tear each year) as a tax deduction. This is great as depreciation isn’t an expense you have to pay from your bank account. New houses can claim higher depreciation but even on new properties the amount you can claim reduces over time.
Property is also illiquid ie you can’t sell a bathroom to pay for the first year of private school and as such it’s often not used for funding children’s education.
I have heard of clients buying property so they can “give to their children” when they are older. A change of name from your name to their name would results in capital gains tax and stamp duty implications (see below)
Who Should own the Investment?
Deciding who should own the investment can be a very complicated tax area and definitely one where you need to get expert tax advice.
You could own the investment in your child’s name depending on how much you are investing this may not be the best option as the Australian Tax Office (ATO) could see this as you trying to “hide money” and assess the income in your own name. Furthermore penalty child tax rates of up to 66% can apply (however children can earn $416 without any tax though).
One Parent’s Name OR Joint Names
The investment may earn income each year. So if a spouse earns less it may make sense for the investment to be held in their name so any income is taxed at a lower tax rate.
The other consideration is capital gains tax at sale. When you sell the investment you get taxed on any growth (but if you hold for more than 12 months then you only get taxed on half of this gain).
|When sell Investment is worth:||$30,000|
If you have held the investment for more than 12 months then only ½ of this is capital gain is assessable.
So $5,000 gets added to your tax return and taxed like any other income.
Depending on how much other income each partner earns each year during the life of the investment and at the time of sale will determine if it’s better to invest in one or joint names (remember in Australia the more you earn the more you get taxed)
This income or capital gain could also affect things like family tax or child care benefit.
If you invest through an Education Bond then all income is taxed internally by the bond at 30% (this could be less than your individual tax rate depending on what your salary and other income is).
Any withdrawals made from the Education Bond are taxed in the student’s hands.
If the student is under 18 they can only earn $416 before penalty tax rates on unearned income kick in.
BUT if you withdraw and use the money for education expenses then you get a rebate for any tax the fund has paid which can help reduce the tax.
You can also choose to take the withdrawal from the capital (the amount you originally invested) not earnings of the fund which would not result in any tax.
Any withdrawals used for education expenses attract a 30% rebate for tax the fund has paid along the way as well as not paying any tax until income exceeds $18,200.
Only withdrawals of earnings to pay education expenses receive the tax offset. Again you can also choose to take the withdrawal from the capital (the amount you originally invested) not earnings of the fund which would not result in any tax.
What happens if you don’t use for education purposes?
Withdrawals for other purposes do not attract the tax offset and is taxed like an investment bond (refer to else where in article for details)
If you invest through an Investment Bond then all income is taxed internally by the bond at 30% (this could be less than your individual tax rate depending on what your salary and other income is).
Generally, any withdrawals made in the first 10 years are taxed in the hands of owner as outlined in the table below.
|Year||Year Taxable Component (amount withdrawal added to your tax return)*|
|Years 1–8||All earnings|
|Year 9||2/3rds of earnings|
|Year 10||1/3rd of earnings|
* Any amount received from an investment bond that is included in a person’s tax return is entitled to a 30% tax offset. The tax offset is non refundable which means that there is no tax refund if the tax offset exceeds the tax payable.
Some people interpret an investment bond as being tax free after 10 years. But in fact, it just no longer gets taxed in your tax return. Any income or capital gain on sale has been taxed by the investment bond at 30%. One of the downsides to an investment bond is that you don’t get the 50% discount on the capital gain.
Income the investment bond earns doesn’t get included for family tax benefit or child care benefit calculations. However, withdrawals before 10 years may get added to your assessable income and impact these payments.
Now I know the above is a lot to take in so if you are still feeling a bit lost or know you just don’t have time to implement yourself then feel free to connect with me (firstname.lastname@example.org) about our My Money Independence program as investing for kids is definitely something we cover as part of this program.
*FPA Share the Dream Report
** https://au.spindices.com/indices/equity/sp-asx-200 click on sector to see break up
The information (including taxation) provided in this blog is general in nature and does not consider your individual circumstances or needs. Do not act until you seek professional advice and consider the Product Disclosure Statement. The author, Adele Martin, is a Certified Financial Planner at Firefly Wealth which is an Authorised Representative of RI Advice Group ABN 23 001 774 125 AFSL 238429. The views expressed in the blog are solely those of the author, they are not reflective or indicative of RI licensees’ position and are not attributed to RI Advice Group. They cannot be reproduced in any form without the written consent of the author. The tax rates and information included are effective for the 2018/19 financial year and are subject to change.
The information (including taxation) provided in this blog is general in nature and does not consider your individual circumstances or needs. Do not act until you seek professional advice and consider the Product Disclosure Statement. The author, Adele Martin, is a Certified Financial Planner at Firefly Wealth which is an Authorised Representative of RI Advice Group ABN 23 001 774 125 AFSL 238429. The views expressed in the blog are solely those of the author, they are not reflective or indicative of RI licensees’ position and are not attributed to RI Advice Group. They cannot be reproduced in any form without the written consent of the author.