Parents and grandparents with the means to do so, often wish to help their children or grandchildren financially with education costs, purchase of a house or car, or overseas travel.
But investing on behalf of a child has its complications and there are various rules that must be considered. For example, did you know that children under 18 and not earning an income are taxed at the highest marginal tax rate? This means that if you invest in your child’s name, he or she will lose almost half of their gains in tax. The Australian Taxation Office (ATO) established these rules to prevent parents from investing their money under their child’s names as a way to avoid paying tax.
There are other complexities when it comes to adults investing on behalf of children. Often, the adult will still be regarded as owning the investment (if their money was used to fund the investment and it’s in their name) and this may impact the parents’ Centrelink entitlements. There are also gifting rules around the Age Pension that must be considered.
How about Estate Planning considerations? If the adult were to pass away (an important consideration for grandparents), and they are still the legal owner of the assets, the investment would form part of their Estate. Even if these assets are to be passed on according to the Will, issues could arise if another family member wished to contest the Will.
One way to reduce all this complexity is through an Investment Bond. An Investment Bond allows you to invest in various asset classes such as cash, fixed interest, property and shares. Investment Bonds have a unique tax treatment and are particularly useful for long term investments such as a child’s costs of education.
An investment bond has a number of key advantages over other investment products:
– Tax effective: income is taxed inside the bond at the corporate rate (30%) rather than your marginal rate (great for high income earners looking to get their kids into private schooling).
– No capital gains: when you switch between investment options, you don’t incur any capital gains tax (whereas you do with managed funds).
– No impact to your tax return: there’s no need to include anything (income or capital gain) on your tax return if your funds remain invested for 10 years. If withdrawn in less than 10 years, tax rebates apply.
– After 10 years there is no tax liability whatsoever on withdrawals. That’s right, if you keep your investment bond ticking away for ten years you will not pay any tax on the proceeds when you withdraw.
– You can access your money at any time (just like any other managed fund, which should give you peace of mind).
– You can nominate beneficiaries (the kids) and the proceeds can be paid very quickly and directly to them with no tax implications. Proceeds do not go via the estate so it cannot be contested.
How it all works in practice
The adult is the policy owner who nominates an age (between 10 and 25 years old) when the policy is to be transferred into the child’s name. No stamp duty is payable on the transfer. At the time of application the nominated child needs to be less than 16 years old and if no vesting age is nominated, the transfer automatically occurs at age 25.
You can set up multiple Investment Bonds for specific purposes. For example one for university education, another for a house, and so on.
You can begin with a lump sum, or as little as $500. You can also make extra contributions to your investment bond each year, provided you don’t invest more than 125% of your previous year’s investment amount. If you do, the ten year tax free period starts again.
Of course investing on behalf of a child or grandchild requires considerable research and consideration. And the most suitable option for you will depend on a range of factors such as your tax position, the child’s situation, grandparent’s situation and how and when the investment needs to be accessed.
It always makes sense to talk to seek professional advice specific to your situation before proceeding with a strategy. If you would like to discuss these options in more detail, please contact your financial adviser.