Investing on behalf of your children can help give them a financial leg up and introduce them to good financial habits at an early age. So, what is the best way to invest for your children – bonds, term deposits, shares, property or super? Here are some considerations to help you find the right kind of investment vehicle to set them on their way.
Knowing the power of compound interest, you may want to kick-start your child’s home deposit savings or help towards a university degree without taking on any debt.
Whether your children are still crawling around the living room floor or getting ready to graduate from high school, there are plenty of ways you can invest in the future.
Let’s break it all down.
Before you start investing for your child
One thing to consider before diving in, is that you’re taking care of yourself before you start investing for your children. Do not start investing for your child if you have to stop investing for your own financial future.
It’s best to be prepared financially so you don’t end up depending on your children during your retirement years!
Picking the right investment for your child
How much you have available for investment, what assets you currently hold, tax, and investment timeframe can all make a big impact on the best way to invest for your children.
The first thing to consider is why you want to invest. With so many products, you need to 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.
On the other hand, you can open a bank account to give them the feeling of ownership. A way to establish financial literacy in adulthood.
Tertiary education doesn’t come cheap. To avoid this long-term expense and help your children harness the power of compounding, many parents and grandparents like to establish some form of investment vehicle for their children.
One thing to consider if you already have a mortgage, you may be better served paying any spare cash into your home loan before establishing a separate investment vehicle.
For parents who may have already paid off their home loan, or perhaps grandparents wanting to invest on behalf of their children, products such as investment bonds may make sense.
Sometimes called insurance bonds, investment bonds are a good option for achieving goals which are 10+ years away. They are a type of investment-savings plan, and because earnings are taxed within the bond at 30 per cent, they’re considered ‘tax-paid’ investments.
These products are popular as a way to save for a child’s education expenses, and also home deposits because they can “vest” into their ownership when the child reaches a certain age. This can be a tax-effective way to save for a child’s future.
The limitation with investment bonds is that they do have some restrictions and aren’t as flexible as other investment options. They only allow you to contribute up to 125% for the prior year’s contributions. For example, if in the first year you start the bond with $10,000 the next year you can contribute $12,500 the next year $15,625 and so on. However, if in the first year you contribute $10,000 and the next year you contribute $1,000 this year you can only contribute $1,250. Care should be taken with the regular contributions to ensure either the correct amount is contributed in the first year or a regular contribution plan is set up for the intended investment timeframe.
High-interest savings accounts
If you have a small amount to invest, this high-intertest account could be the way to go. They are relatively simple to set up and administer plus they can show children the power of investing. To be effective these basic savings accounts need to be kept to low amounts due to the penalty tax for minors.
According to the Australian Tax Office (ATO), there are special rules that apply to children under 18 in regards to tax-free threshold applying to interest earned on the accounts. See the ATO website for more information.
Parents offset account
An offset account typically offered with a home loan package is simply a transaction account that is linked to a home loan. Money in an offset account offsets against the loan amount, meaning you only pay interest on the remaining balance. The more money you have in the offset account, the less interest you’ll pay on your loan.
Why put your children’s savings in the offset account? Firstly, if the child’s unearned income is approaching the $416 threshold, you may want to put it in an account where the money can grow, at the same time avoid punitive tax rates. Secondly, the child’s money can contribute to the reduction of the parent’s interest payable on the loan.
Many financial institutions offer an offset feature, some even allow multiple accounts to be linked to a loan, so parents could designate a single offset account solely for their child’s savings.
Equities – Shares/ETFs
Equities have traditionally provided a higher rate of return compared to a savings account.
Minors can’t legally own shares. The most popular way to purchase shares for a child is to have an adult purchase and hold the shares in trust for the child. Therefore, the parent is the legal owner of the shares and the child becomes the beneficial owner of said shares. Shares can be acquired directly, or you can regularly invest a set amount into a professionally managed portfolio. If you select the managed strategy, it is often simpler, removes much of the emotions from the process, and if the portfolio is linked to your personal superannuation and wealth account we can use family linking to lower the fees you are paying.
When the child becomes of age, the adult can transfer ownership of the shares to the child. The child now legally owns the shares in their name and there is no capital gains tax incurred as the beneficiary has not changed.
More information on the tax treatment of shares for children can be found here.
As you can see there are plenty of different options to invest on behalf of children. It all comes down to personal circumstances, risk profile, investment timeframe and personal preferences.
If you want to discuss how to start investing for your children or grandchildren, get in touch with your adviser or call us on 02 9232 6800.
It’s imperative that you speak to your adviser or accountant prior to investing on behalf of a minor. Tax implications can be significant and everyone’s situation is different. The information in this blog post is general advice and does not consider your individual objectives, financial situation or needs. You should consider whether the advice is suitable for you and your personal circumstances. Before you make any decision about whether to acquire a certain product, you should obtain and read the relevant product disclosure statement. Should you have any questions please contact us on 02 9232 6800.