With the cost of housing continuing to climb, in addition to the rising cost of tertiary education, many parents and grandparents are worried about what the future holds for the young people in their lives.
Last week Michael contacted me. He has a young daughter and was thinking of starting an investment for her, where he’d perhaps tip in $25 a week so that when she was a young adult there’d be a pool of money to get her off and running.
He’d seen a lot written about exchange traded funds (ETFs) so he figured that they must be the way to go. But his initial inquiries weren’t bearing much fruit and so he wanted to know whether there was something he was missing.
The first barrier Michael found was that he couldn’t actually establish an investment in his daughter’s name. There are two reasons for this.
First, to establish an investment, whether buying shares through a broker or in a managed fund, you are engaging in the world of contract law, and contracts can’t be enforced on minors.
It may be possible in some instances to transfer investments to children under 18 after purchase but that then brings us to the second reason why investing in your child’s name is problematic – minor’s tax.
This is a penalty tax regime designed to prevent wealthy parents from hiding assets in their children’s name. Children can pay an amazing 66% tax on investment income.
So the investment will probably need to be in an adult’s name – usually one of the parents (it could even be in both names).
And the adult owner will need to include the investment income, and hopefully capital gains, on their tax return.
Given this, it would be sensible to have the investment in the name of the parent likely to have the lowest income, since this will result in the lowest tax payable.
Most investments will allow you to put a designation on the account that is like a tag, so you might have “Jane’s investment”. These designations have no legal or tax impact but they help in identifying investments.
If these tax consequences are a significant barrier, most likely because both parents earn incomes of over $80,000, then another solution is to use insurance bonds or a derivation of them, child advancement policies.
Insurance bonds are a little like super funds but without the restrictions of access to your money. They pay tax within the bond (at 30%), so you don’t need to include them in your personal tax return.
If you hold them for 10 years or more, then when you withdraw the funds – for instance, to gift to your daughter so she can buy her first home – there is no further tax to be paid. This is quite different from a regular investment in one of the parents’ names, where upon sale capital gains tax will be payable (assuming there has been growth, of course).
If you are saving specifically for education purposes, child advancement policies can be helpful. These enable you to claim back the 30% tax paid within the bond where you can demonstrate that withdrawals are being made to fund education expenses.
Whichever ownership structure you decide is right for you, one final note is that while ETFs have many great applications, regular savings plans are not one of them. Brokerage is a killer.