Giving children a head start
With the rising cost of living, it’s easy to become focussed on immediate expenses and forget about the bigger picture. But if you want to give your children or grandchildren a better start in life – with education or a home deposit, it’s good to start planning early on. Five or ten years down the track you’ll be happy you did!
One way to save for your children or granchildren’s future is to set aside money for them in a managed fund. Managed funds offer more investment choice than some other options such as education funds, and have diversification benefits. Even if you have only $2,000 to invest, some funds will allow you to access a range of different investments across different asset classes. Investments can be tailored to suit specific goals and time horizons. For example, while growth assets could be used to pay for high school or university education expenses, income producing assets may be used for more immediate expenses like books and uniforms.
As managed funds generally do not allow children under 18 to own the investment directly, the main issue is whether to hold the fund in trust for the child or in your own name. Some important considerations are who will be liable for tax, whether a trust may affect your social security entitlements and how you want to manage capital gains tax.
What the tax man thinks
With many people previously using children’s accounts to hide their own money and avoid paying tax on earnings, the Government introduced a penalty tax rate on unearned money held by a minor (a child under 18). This includes income from dividends, interest, royalties and property but does not include income a child has earned themselves through employment or business.
Below are the tax rates that apply to unearned income for a child under 18 in the 2008/09 tax year.
Eligible taxable income | Tax payable |
$0 - $416 | nil |
$417 - $1,307 | 66% of each $ > $416 |
$1,308 + | 45% of all taxable income |
As a minor can claim the low-income rebate, they can earn up to $2,667 (in 2008/09) a year before they are liable to pay tax. But they will need to submit a tax return.
From the ATO’s perspective, the person who owns the money is liable to pay tax on it. Just because an investment is held in trust doesn’t necessarily mean the ATO will consider it the child’s investment. For example, if the parent opens the account in trust for the child but spends the money as if it belongs to them, it will be treated as belonging to them. If an investment is genuinely held in trust for a child, it’s important to document it as the ATO may request all relevant documents from the bank and taxpayer.
The best person for the job
Where one parent or grandparent is on a low marginal tax rate, and especially when they are not using their tax-free threshold, it could be a good strategy to hold the investment in their name. This way investment earnings up to the tax-free threshold will be effectively tax -free, while earnings above this potentially will be taxed at a lower rate than their parent’s marginal tax rate.
High income earning parents may also consider investing in a fund with high growth rather than income to minimise the tax liability.
Grandparents or low-income earning families should also weigh-up the impact being a trustee for a child’s investment may have on their own benefits. Depending on the circumstances, investments may be assessable under the assets test and income under the income test, so it’s best to contact your local Centrelink office or speak to us before becoming trustee.
Capital gains tax
If the investment is genuinely held in trust, it is held for and considered to be for the beneficial ownership of the child. This means when the trust is transferred to the child, Capital Gains Tax (CGT) will not be triggered. But when the child subsequently sells the investment a capital gain or loss may be realised and they must declare it.
If the investment is sold prior to being passed over to the child, a capital gain may be realised and subject to CGT. Similarly if the parent or grandparent has been claiming the investment income in their tax return, the ATO may argue that transferring the investment is a capital gains event. In this case the trustee would be responsible for any CGT.
If the trustee dies, there is no capital gains consequence on the investment passing to a new trustee.
What are my options?
You can avoid any problems arising under a trust arrangement, by investing money directly in the child’s name through a bank account or term deposit. But obviously this does not provide exposure to different asset classes or the same growth potential as a managed fund.
Another option is placing funds in an insurance bond in the parent’s name, with the child as the life insured. In this case the insurance bond would be issued as a child advancement policy, which means it can be transferred to the child at a nominated age generally between 10 and 25. Alternatively, education funds are marketed towards adults wishing to invest for children. Both these investments have tax benefits but are not as flexible as managed funds with penalties for early access.
A super option
With its beneficial tax treatment, pre-retirees planning to retire in the next five to ten years may wish to use their super to save for a child or grandchild’s future. For higher income parents or grandparents close to retirement, it can even be beneficial to salary sacrifice into super while borrowing for a child’s education expenses. Once you retire, and as long as you’re aged 60 or above, you can use a tax-free lump sum to pay off the loan. The benefit of this strategy is saving all those pre-tax dollars when you salary sacrifice.
As you can see investing for a child or grandchild is quite a complicated business so it’s a good idea to get advice from your financial adviser. We can advise what option is suitable for you and can provide strategies to minimise tax.