Investing for Your Children or Grandchildren
As parents or grandparents, you have a unique opportunity to set up a secure financial future for your children or grandchildren. Investing for them can provide a substantial head start, whether it’s for education, property, or simply helping them navigate adult life. However, with numerous investment options and Australian tax laws to consider, it’s essential to make informed decisions that align with your goals and the financial well-being of your loved ones.
Why Invest for Your Children or Grandchildren?
The Power of Compounding:
By starting early, even relatively small investments can grow significantly over time due to the magic of compound interest. The earlier you invest, the longer those investments have to grow.
Future Financial Security:
Setting aside funds for your children or grandchildren can help ensure they have the financial resources to support major life events, such as university education, purchasing their first home, or starting a business.
Estate Planning:
Investing in your children’s or grandchildren's future can also be part of a broader succession plan, helping to reduce your taxable estate while passing on wealth in a tax-efficient way.
Key Investment Options
There are several ways to invest for your children or grandchildren, each with its own benefits and considerations:
Savings Accounts or Term Deposits:
Savings accounts or term deposits in the name of your children or grandchildren are one of the simplest ways to start investing. However, the returns are relatively low, and Australian taxation of interest income may apply. Minor children (under 18) in Australia have specific tax rules, where unearned income over a certain threshold can be heavily taxed.
Pros: Safe, easy to set up, liquid.
Cons: Low returns, potential tax implications on interest earned.
Investment Bonds:
Investment bonds are an attractive long-term investment option for children and grandchildren. They allow the funds to grow in a tax-efficient environment since they are taxed within the bond structure at a maximum rate of 30%, which is generally lower than the highest personal tax rate. After 10 years, withdrawals are tax-free, making them ideal for long-term goals like education or a house deposit.
Pros: Tax-efficient, tax-free after 10 years, flexible.
Cons: Limited investment options, limitations on additional investments, potential early exit penalties.
Shares or Managed Funds:
Investing in Australian shares or managed funds can provide higher returns over the long term. You can hold these investments in your name, a trust, or directly in your child’s or grandchild’s name. Managed funds, in particular, offer diversification across different asset classes, helping manage risk while targeting long-term growth. Minor children (under 18) in Australia have specific tax rules, where unearned income and taxable capital gains over a certain threshold can be heavily taxed.
Pros: Potential for high returns, diversification, flexibility.
Cons: Market risk, complexity, ongoing management, potential tax implications on income and capital gains.
Superannuation Contributions:
You can also invest in your child’s or grandchild’s future by contributing to their superannuation fund, although contributions are subject to restrictions. Voluntary contributions to super can benefit from the power of compound growth over the decades, but the funds are locked away until your child or grandchild reaches preservation age (currently 60).
Pros: Long-term growth, tax advantages.
Cons: Restricted access until retirement, contribution limits.
Trusts:
A trust can be established to invest and manage funds for your children or grandchildren. Trust structures offer flexibility and control over how the money is distributed. However, they require legal setup and may involve ongoing costs and management. Family trusts can be particularly useful if you want to control when and how the funds are accessed by the beneficiaries.
Pros: Flexibility, control, potential tax advantages.
Cons: Setup and maintenance costs, legal complexities.
Tax Implications to Consider
Taxation plays a critical role in deciding which investment vehicle is most appropriate. Here's an overview of the tax implications for different types of investments for children or grandchildren under Australian tax laws:
Taxation of Minors: In Australia, minors (under 18 years) face high tax rates on unearned income, such as interest from savings or dividends from shares. Specifically, minors are subject to a penalty tax rate to prevent income splitting. The tax-free threshold for minors is $416, and any income above that is taxed at 66% for amounts between $417 and $1,307, and 45% for income exceeding $1,307. This makes direct investments in their names less attractive unless the income is minimal.
Investment Bonds: One of the major advantages of investment bonds is that the earnings within the bond are taxed at a maximum rate of 30%, which may be lower than your personal marginal tax rate. You don’t need to declare the earnings on your tax return unless you withdraw the funds within 10 years. After 10 years, any withdrawals are completely tax-free, which makes investment bonds a tax-efficient way to invest for children or grandchildren.
Shares or Managed Funds: If you choose to invest in shares or managed funds in your child’s or grandchild’s name, capital gains tax (CGT) will apply when those assets are sold. If the shares or funds are held for over 12 months, a 50% CGT discount may apply. However, any dividends earned are subject to the penalty tax rates for minors, as mentioned above. A trust structure can offer some relief by allowing the distribution of income to adult beneficiaries, potentially at lower tax rates.
Superannuation: Superannuation contributions can provide significant tax advantages, with concessional (before-tax) contributions taxed at only 15%, and non-concessional (after-tax) contributions not taxed at all when they enter the fund. However, the contribution limits are strict, and the funds are inaccessible until your child or grandchild reaches retirement age. For this reason, super is best for very long-term investments.
Trusts: Family trusts can be tax-efficient if structured properly. Income earned by the trust can be distributed to adult beneficiaries who are taxed at their marginal tax rates, often resulting in a lower overall tax burden. However, any income allocated to minors from the trust is subject to the same penalty tax rates as direct investments. Despite this, a trust offers flexibility in managing when and how the funds are distributed, providing a level of control that other vehicles may not offer.
How Can We Assist
Investing for your children or grandchildren is a thoughtful and impactful way to provide for their future. Whether you are looking for tax-efficient investment options, assistance with estate planning, or guidance on the best vehicles to support your goals, Arrow Private Wealth is here to assist you every step of the way.
General Advice Warning:
Any general advice on this page does not take account of your personal objectives, financial situation and needs, and because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. Information contained on this page was correct at the time of posting.