How to invest for your children

Investing on behalf of your children can help give them a financial leg up and introduce them to good financial practice at an early age.

Whether it’s birthday cash from proud grandparents, a slice of an inheritance, or you just want to set them up with something in their own name, many parents want to invest on behalf of their children.

While children can't trade shares themselves, it's never too early to get kids interested in money matters, and there are several ways for parents or grandparents to invest on behalf of a child.

Here are some considerations to help you find the right kind of investment vehicle to set them on their way.

Picking the right investment for your child

Just as you wouldn’t set off across the Nullarbor on a hovercraft, it’s important to pick the right vehicle.

Tax, social security and the appropriate structure will all affect your decision.

The first thing to consider is why you want to invest.

There’s a plethora of products you could select, so think about which goals you’re aiming to achieve. Setting something up to fund year-on year educational expenses might be quite different from a fund to establish a deposit on a first home, where the aim is a lump sum.

Alternatively, you may simply to want to open a bank account to give them the feeling of ownership, the equivalent of the old over-the-counter passbook. This might be a first step towards financial literacy in adulthood.

Once you’re clear about your aims, it pays to bear in mind the effects of taxation.

Minors and tax

In Australia, children under 18 on the last day of the financial year (30 June) are considered minors as far as tax is concerned.

Minors are generally taxed at penalty rates on unearned income such as interest, rent and dividends.

This is to discourage individuals from splitting income or putting strategies in place to avoid tax.

In whose name?

The most common approaches are to hold the investment in the child’s name, or in the parent or grandparent’s name, with them as a trustee.

Whichever you choose, it helps to think upfront who will be liable for any tax and what the social security impacts might be.

Be mindful of not just considering the income tax derived from earnings, interest & dividends, also have the end in mind and the affect potential capital gains tax will have on your long term objectives.

For tax purposes, the ATO determines who has control of the assets, and therefore who pays tax on the income earned.

Grandparents

When placing an investment in a grandparents name - it may be beneficial to you (as the parent) and the child, as the grandparent is no longer working and therefore you can use up their tax free threshold.

However, you need to consider the entire situation, as additional investments or income may affect the grandparents Age Pension entitlements.

Furthermore, there are other considerations that you may investigate with grandparents, including superannuation/pension phase investments where the tax rate is 0-15% depending on age and their situation. However, this strategy comes with a plethora of risks; including but not limited to; grandparents passing and you aren’t the beneficiary, eating into grandparents contribution caps, and then there is accessibility restrictions too.

Recent strategy considered - reducing the tax from 47% to 15%

Investment vehicles

These are some of the popular options parents turn to.

Bank accounts

Opening a bank account is usually the most straightforward. This doesn’t require the child to sign a legal document and so can be registered with your child’s name. However, if they are under 16, the bank will often require parental permission.

Managed funds

Managed funds and share investments generally require legal capacity, which doesn’t apply to under-18s. Therefore, these are usually registered in an adult’s name. The fund manager or share registry may allow for a name that reflects the intention, ie John Smith in trust for the late Jane Smith.

Insurance bonds

An insurance bond is a type of life insurance policy, with a range of investment options. It may be withdrawn in part or full at any time, although there may be tax implications. It can be established in the child’s name for those aged 10 to 16 with parental consent. Anyone over 16 can invest without consent.

For children under 16, insurance bonds generally also offer a ‘child advancement option’, where a parent or grandparent invests on behalf of the child, with ownership passing at a nominated ‘vesting’ age. This might tie in with making funds available for education, home deposit or travel and so on.

Superannuation

Although it may seem odd for an under-18 more into computer games, it’s never too early to think about super.

Children can become members of a super fund, if the rules of the fund allow this. Generally, a parent or guardian needs to sign the application form and there are additional considerations if the child will be a member of a self-managed super fund (SMSF).

Because of its concessional tax treatment, super is a popular savings vehicle. However, depending on your purpose for setting up the investment, it may not be right for your child as they may not be able to access their funds until their own grandchildren start playing computer games.

Another option is to utilise their grandparents concessionally taxed superannuation accounts. However, this is not without its risks.

Social security

Where a parent or other adult holds investments on behalf of a child, Centrelink typically treats these as protective trusts. As a result, assets will most likely be attributed to the adults, up until they transfer to the child.

Summary

One of the key elements of investing for your children is to increase their financial literacy.

“Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”

The same can be said about financial education and financial literacy.

Getting your children involved and interested in investing can establish their financial fundamentals that can set them up for life, including teaching them the value of money, how compound interest works, what to look for when investing, diversification, how dollar cost averaging works & how the government takes a cut of whatever you earn through taxes.

It’s important to evaluate the pros and cons of each strategy, entity and investment, to get the right approach for your family.

These can be complex, so you may wish to speak to your Newcastle & Lake Macquarie Financial Planning Adviser.

Sources:

https://www.amp.com.au/insights/plan-my-future/investing-on-behalf-of-kids

https://www.moneymag.com.au/buying-shares-for-kids-grandkids

https://www.marketindex.com.au/buying-shares-for-a-child

https://www.abc.net.au/everyday/how-to-invest-money-for-your-kids/11965706