Investing for children

There’s no question about it. Raising children can be a fun, challenging, rewarding – but at the end of the day – quite expensive exercise!

According to figures in the latest AMP/NATSEM Income and Wealth Report released in May 2013, the “lifetime shopping bill” for two children from birth until age 21 is between $812,043 and $1,097,278 for middle to high-income families.

Putting this into some perspective, that’s a 50% increase since 2007, reflecting rises in the “big ticket” items of housing, clothing, food, energy, transport, recreation and education.

And research shows that adult children are increasingly remaining dependent on their parents, in part due to lifestyle choice, as well as factors such as lower housing affordability and extended education.

As a parent, it’s natural to want to provide for your children and to give them a “step-up” in life. Given the costs, it’s important to prepare financially for the expenses involved as early as possible.

Things to consider

There are many factors to address before implementing a savings or investment plan for children. Timeframe, tax, the ownership and control of the investments, overall goals and the appropriateness of particular investment options are just some of things to take into account.

Minor tax rates

Penalty tax rates for minors were introduced in the late 1980s to stop parents reducing their own tax bill by splitting their income and diverting it to their children.

A child is considered a minor for tax purposes where they are under the age of 18 at the end of the financial year. Certain minors are excluded from the special rules and are called “excepted persons”.

In the 2012–13 income year an Australian tax resident minor who is not an excepted person and has only unearned income will pay tax as follows:

Ownership of investments

The most common ways to structure investments for children include:

1. Investing in your child’s name

This can result in a significant tax bill due to the minor tax rates. If the investment is likely to generate significant income or capital gains, it may be better to invest in another name or structure.

1. Investing in an adult’s name

Investments for children can instead be made in the name of a parent, grandparent or other adult person.

The adult will have to declare any income and capital gain from the asset in their assessable income and will pay tax at their marginal tax rate.

It is also important to remember that capital gains tax may be payable when ownership of the investment is transferred to the child in the future.

1. Investing with an adult as trustee for the child

Many institutions will not accept investments in the name of a minor. One way around this is to invest with an adult as trustee for a child.

The tax treatment will depend on who the Australian Tax Office (ATO) decides really owns the investment. In determining this, the ATO considers the source of the funds, who controls the investment, and who benefits from the investment.

If an investment is genuinely held in trust (whether formally or informally) it is held for the beneficial ownership of the child. If and when ownership is transferred to the child, the beneficial ownership is unchanged. There will be no capital gains tax (CGT) liability until the child subsequently disposes of the investment.

However, if the trustee has declared the investment income in their own tax return, then when the ownership of the investment is eventually transferred to the child, the ATO may argue that there has been a change in beneficial ownership. In this case, the trustee will be personally liable for any capital gain arising from the transfer of the investment to the child.

The ATO is reluctant to accept that an investment is controlled by a child if it is held ‘as trustee’ for the child. If you choose this ownership structure, keep evidence that the income is for the sole use of the minor and clearly state the intention to transfer the investment to the minor upon turning 18 years.

1. Formal trust structures

A trust is a legal arrangement in which money or property is managed by one person (or organisation) for the benefit of another. Formal trusts are operated under the terms and conditions set out in a trust deed.

One of the advantages of family or discretionary trusts is the flexibility to distribute income.

Downsides of using a family trust include the initial cost of establishment, as well as the ongoing accounting responsibilities.

Trusts can be set up both during your lifetime, and as part of your will.

Investment alternatives

You can use a range of investment vehicles when saving and investing for children, including:

• bank accounts such as dedicated children’s’ accounts and high-yield internet savings accounts;
• term deposits;
• managed investments such as investment bonds, scholarship funds, managed funds;
• direct shares and property;
• superannuation;
• saving into a home mortgage with a redraw or offset account.

Each option has its pros and cons, and it’s important to match the investment with your timeframe and goals.

A bank account, for example, is great for a short-term investment, because it provides immediate access and a certain return. If you’re saving for a long-term goal, such as funding university fees, then an investment such as shares which provides capital growth could be more appropriate.

If you’re thinking of investing for your children, or want to review your current strategies to make sure they still meet your needs, please contact your Bongiorno advisor