Set and review
Parents should begin by setting goals when investing money for their children’s futures. The goals may change over time, but being clear about the investment’s aims and regularly reviewing them – with the children’s input where possible – can help keep everyone on track and avoid disagreements in future, says Morris.
When setting goals, parents should be realistic about how much can they afford to put aside and consider their timeframes, says ANZ Senior Financial Advisor, Rebecca Hurford.
“If it’s for a baby who has just been born it’s a longer timeframe for investment. If it’s for a child who is already in primary school, and the parents want to set money aside for private school fees, in the high school years, the timeframe is shorter,” Hurford says.
Risk and return
The investment duration, along with the parents’ risk tolerance, will determine what types of assets are suitable.
People who aim to use the money within one to three years should consider low-risk bank deposits, “as unattractive as that is with interest rates as low as they are,” says Hurford.
Over longer terms, say five years plus, parents could consider more growth-oriented investments that can be expected to deliver higher returns over time, such as direct shares, managed funds, exchange traded funds (ETFs) or property.
“If you’re seeking higher returns on your money you’ve got to take a bit more risk, so you may invest more into the share market. If you want a more cautious return with less volatility, you would have less in the share market,” Hurford says.
Holding market-based investment for children allows easy access to the money and the flexibility to vary the amount you contribute each year.
Managed funds and ETFs allow you to spread money across a range of asset classes. Diversifying in this way mitigates risk to the overall investment, as gains in one asset class could compensate for losses in another.
Tax is a key issue when determining the best way to invest money for your child. Australia has an extremely low tax-free threshold for children, which means they pay a significant amount of tax on investments held in their own name.
Income from deposits and investments must be declared on the asset owner’s tax return. Capital gains made when an investment is sold are also taxed.
“You would typically hold the investment in the names of one or both parents, depending on which tax bracket they sit in, as trustee for the child. You typically don’t put it in the child’s name,” Hurford says.
Everyone’s situation is different. Hurford suggests parents seek personal taxation advice from a professional tax advisor.
With a timeframe of 10 years or more, parents looking for tax-effective investments for children may find investment bonds (also called insurance bonds and education bonds) fit the bill.
Investment bonds are financial products offered by some insurance companies. Like managed funds, they offer a choice of investments from property and shares to fixed income, or a split between asset classes.
Income and capital gains are taxed within the investment bond at the company rate of 30%. Franking credits can lower the tax rate further. Importantly, there is no year-by-year impact on the investment owner’s personal tax return, says Hurford.
“Once that bond has been held for greater than 10 years, there are no capital gains tax consequences for the investor,” she adds.
Investment bonds can be set up initially in the parent’s name, with ownership reverting to the child at a trigger point – the child turning 18 or 21, for example. This eliminates capital gains tax and stamp duty consequences that can arise when assets change ownership.
Investment bonds do have limitations.
Contributions to the products are capped at 125% of the previous year’s contribution.
“If you don’t add to it one year, then you can’t contribute in the following years. If you do decide to contribute again, you will reset the 10-year timeframe,” says Morris.
You would then have to wait another 10 years before withdrawing money, or face paying tax on the investment’s capital gains.
Not so super
Investing in your child’s superannuation fund is another tax-effective option. Income and capital gains made inside superannuation are taxed at just 15%.
The major drawback to superannuation is that the money is locked away until the child meets a condition of release, which generally means turning 65.
“You wouldn’t usually set a retirement age goal for a child,” Morris says.
For most families with investments for their children, simple strategies will be enough. But family trusts that name the child as a beneficiary can be helpful in some situations, says ANZ Financial Adviser, Michelle Li.
Parents who run a business, for example, may want to protect the assets set aside for their child from creditors should their business fail.
Li has a wealthy client who manages and part owns a listed company overseas. He wants to invest for his 12-year-old daughter who is studying in Australia.
The client’s personal assets are liable to anything that happens to the company so investing in his own name would leave the assets exposed.
Li considered a tax-effective investment bond that would revert to the daughter’s name when she was old enough to take responsibility for the investment.
“At that point, the investment has no relationship to him. However, the investment is still exposed to the risk until the point at which it can be transferred into his daughter’s name” she says.
Instead, the client set up a family trust, which held the investment bond.
“From a legal point of view, it’s a different entity and has nothing to do with the dad,” Li says.
This provided an extra layer of protection to ensure the investment would go to the daughter.
Whenever you make investments for your children, you will likely achieve the best outcomes if you plan carefully and seek professional advice.