Investing for your kids or grandchildren

Transcription

1 Investing for your kids or grandchildren ebook special Ever thought about investing for your kids or grandchildren? It might be simpler than you think. Co-founder of the Switzer Super Report and founding CEO and Managing Director of CommSec, Paul Rickard, has put together a three-part series so that you can learn to invest well for your loved ones. Sincerely, Peter Switzer Inside this Issue 02 Investing for your kids or grandchildren - part 3 Tax benefits 05 Investing for your kids or grandchildren Part 1 Christmas present Investing for your kids or grandchildren Part Investing for your kids or grandchildren Part 2 Thank you later Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No Queen Street, Woollahra, 2025 T: 1300 SWITZER ( ) F: (02) Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual's objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

2 Investing for your kids or grandchildren - part 3 Key points Insurance bonds (also called investment bonds) are long-term investment vehicles that offer tax efficiency for some investors. Insurance bonds usually include a child advancement policy Education savings plans are designed for saving for tertiary education and can be a tax-free way to save. In the lead up to Christmas, we have been looking at how you can invest on behalf of your kids or grandchildren. In the first part of this 3 part series, we covered how minors (people aged under 18) are taxed, whether your child needs a TFN (tax file number) or not, who is liable for paying any tax and we also reviewed some of the bank deposit accounts especially designed for kids. (Click here for our first article). Last week, we discussed how to buy shares directly for your kids either in a portfolio you create, or in a pre-mixed share pack. (View here). In the third and final part of this series, we look at two indirect investment options insurance bonds and education savings plans. What is an insurance/investment bond? Insurance bonds (also called investment bonds) are long-term investment vehicles that offer tax efficiency for some investors. While technically incorporating a life insurance element, they are tax paid investments that focus on wealth creation by investing in single asset (eg. Australian shares ) or multiple asset classes (eg. balanced ). Insurance bonds are designed to be held for at least 10 years. The issuer of the bond pays tax on the earnings of the underlying investments at the corporate tax rate of 30%, which under a special tax rule, means that the investor does not need to include any investment earnings in his or her tax return. After 10 years, the investor can redeem the insurance bond and won t be liable for any capital gains tax. If the investor chooses to redeem the insurance bond before 10 years, he or she is required to pay tax on the earnings of the bond at their marginal tax rate, less a tax offset of 30% to reflect the tax the issuer has already paid. If the bond is redeemed during the ninth or tenth year, transitional provisions apply. One additional rule (known as the 125% rule) makes them attractive as savings vehicles. Under this rule, investors can make additional contributions up to 25% of the previous year s contribution with the benefit of these contributions being treated as if they were invested at the same time as the original investment. For example, if you invested $1,000 to start an insurance bond, you could invest a further $1,250 in year two and a further $1, in year three and have, for tax purposes, the same 10-year term expiry being the tenth anniversary of the original $1,000. How do they work for kids or grandchildren? If the child is 10 years or over, then with parental consent, the investment can be made directly in the child s name. The minimum investment for some insurance bonds is as little as $500. Most insurance bonds also include a child advancement policy. Under this feature, the 02

3 investment is initially made in your name and at a certain nominated time (known as the vesting age ), the bond is automatically transferred to the child. Vesting does not trigger any tax consequences, and there are usually no fees or charges. The child must initially be under 16 at the time the policy is taken out, and the vesting age can be any age from 10 years to 25 years. Who issues them? Insurance bonds are issued by life insurance companies. Three of the major issuers and details of their bonds are detailed below: Pros and cons As they are tax paid investments, and you can invest in relatively small starting amounts, they are attractive vehicles for investing for your kids or grandchildren. There are no issues with the minor s unearned income tax and in most cases, the tax paid rate of 30% on an insurance bond is going to be more tax effective than the minor s tax rate of 45%. The 10-year investment time frame (minimum) will probably not be an issue for most parents or grandparents considering this alternative. Two downsides are the management fee (these range from 1.0% per annum to 1.5% per annum), and unlike direct shares, an insurance bond may not be quite as effective in helping your child or grandchild to develop an interest in investing. Choosing an insurance bond If selecting an insurance bond, look at a growth oriented option such as Australian shares or growth 10-years is a long time. Management fees matter and as it is impossible to predict who is going to be the best performing manager over this period, apart from any other considerations such as the minimum investment size, go for the issuer with the lowest fee. Education savings plans Educations savings plans are designed for saving for tertiary education and can be a tax-free way to save. While they can often be accessed to pay for a child s primary or secondary education expenses, any investment earnings on the savings plan accessed to pay for these education expenses, will be treated as taxable income for your child and potentially be taxed at a minor s tax rates up to 66%. At age 18, an adult child will enjoy a tax-free threshold of $20,542, meaning that investment earnings withdrawn to pay for education expenses will in many cases not incur any tax. Education savings plans can be set up by a parent or grandparent for a nominated student. Technically, they are classified under the Income Tax Act as a scholarship plan. This means that they are tax paid investments (the fund pays tax at 30% on any investment earnings), and when those investment earnings are withdrawn to pay for approved education expenses, the tax the fund has paid is refunded to you in full. Effectively, the fund s investment earnings, if used to pay for approved education expenses, are tax free. Education expenses include tuition fees, uniform costs, books and living away from home allowance (the latter up to $6,900 pa). The potential downside is that the investment earnings, when withdrawn to pay for educational expenses, are treated as taxable income for your child. Lifeplan Education Investment Plan The Lifeplan Education Investment Fund is one of 03

4 only two education savings plans in Australia (the other is provided by Australian Scholarships Group). Lifeplan is part of the Australian Unity group, and offers these plans with 16 different investment options. The initial contribution starts at just $1,000. Every Lifeplan education plan comprises two components. The Investor Contributions account records the balance of investor contributions, and can be withdrawn (tax free) at any time for any purpose. The second component represents the education benefits. This comprises the investor earnings account (that is, the earnings on the investor contributions), plus the tax benefit. The tax benefit is only available when investor earnings are withdrawn to pay for educational expenses, and can be worth an additional $30 for every $70 of earnings withdrawn. Follow the Switzer Super Report on Twitter Also in the Switzer Super Report Peter Switzer: What happens in 2015 and what I will buy soon James Dunn: Why you need international shares in 2015 Rudi Filapek-Vandyck: Buy, sell, hold what the brokers say Roger Montgomery: Why managing money is like managing love Penny Pryor: Shortlisted Energy ETFs, WAM Capital and Hunter Hall Staff Reporter: Annual wrap for auctions If the earnings are not used for education purposes, the plan is treated like an insurance bond for taxation purposes (see above). If the plan had been in place for more than 10 years, withdrawal proceeds are not taxable. Management fees on the 16 options vary between 0.95% per annum for a cash option to 1.74% per annum, and are typically around 1.65% per annum. Be careful with education savings plans Education savings plans haven t been very successful in Australia because they are complex, and only work from a taxation perspective if your child/grandchild is going onto university. With management fees on the high side, they are not good vehicles to save for education expenses for a child under 18. As a set and forget investment they are okay you just need a long time horizon for your child/grandchild. Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances. 04

5 Investing for your kids or grandchildren Part 1 Key points Minors are subject to special rules when it comes to taxation to discourage adults from splitting their income with their children. Unearned income will be taxed at special rates. With the income on fully franked shares, both the dividend in cash and the imputation credits are included as unearned income. There are special bank accounts for kids that can offer up to 3.73% interest under certain conditions. With Christmas fast approaching, the idea of investing for your kids or grandchildren may be something you have been considering. While it is unlikely to produce the same under-the tree reaction as unwrapping the latest Smartwatch or Elsa Doll, when they re a young adult, they should have something material to show for your gift. If the gift is shares or an insurance bond, they may also develop an ongoing interest in investing. In this the first of three feature articles, we will look at taxation issues, including how interest or dividend income earned by a minor is taxed, and applying for a TFN. Then we will road test the bank accounts that are designed for kids. In the second article, we will look at buying shares for minors, and the final article will focus on some of the special investment products insurance bonds and education funds. Taxation Minors (persons under the age of 18) are subject to special rules when it comes to taxation. The rules are designed to discourage adults from splitting their income and diverting it to their children. Unearned income for a minor, which includes income such as interest on a bank account, dividends from shares, or a trust distribution is taxed at the following special rates: Unearned income doesn t qualify for the normal tax-free threshold of $18,200. So for example, if your grandson s bank account earns $1,000 in interest, then tax of $385 will be payable (0.0 x $416) + (0.66 x $584) = $385. When it comes to income on fully franked shares, both the dividend in cash and the imputation credits are included as unearned income. Your child or grandchild will also get the benefit of the imputation credits, which are further applied to act as a tax rebate. Putting these together, if we assume an average fully franked dividend yield of 5%, this means that your child/grandchild can have a share portfolio of $10,677 before paying any tax. Under this size, they will be eligible for a refund in cash of all or part of the imputation credits. Does your child need a TFN? There is no obligation to provide a Tax File Number (TFN) or exemption to a bank or company. If you don t, then PAYG tax on interest or unfranked dividends may be deducted. If you are opening the bank account (or share account) in your name in trust for your child or grandchild, then you should quote your TFN (unless 05

6 there is a formal trust in which case quote the TFN of the trust). Just because you quote your TFN doesn t make you liable to pay any tax. If you are opening the account in your child s name, most banks will generally accept you nominating the child under 16 exemption (this doesn t mean that they won t pay any tax it just means that PAYG tax won t be deducted). If they are 16 or 17 and earn more than $120 in investment income, they should apply for and quote their own TFN. In fact, a child at any age can apply for and get a TFN there is no minimum age. A birth certificate or passport, and one other document, such as a school report is all that is required. The ATO also runs a program with secondary schools that makes getting a TFN easy. from the account is considered to be Shauna s. Bank accounts Banks will typically recommend that you open a bonus interest rate style account for kids. These accounts are structured to reward regular deposits. As the following table shows, your child can earn interest at a rate of 3.73% pa provided one deposit is made per month (usually no size requirements), and no withdrawals are made. Who is liable for the tax on the income? Notwithstanding whose TFN is quoted, the ATO says that who declares the interest depends on who owns or uses the funds of the account. The parent (or grandparent) owns the money if they provided the money and they spend it as they like, whether or not they spend it on providing resources for the child. If the parent owns the money, the parent includes the interest in their tax return. In the case of a bank account, the ATO provides the following examples: Wayne opens an account for his son by depositing $5,000. Wayne is a signatory to the account because Jack is two years old. Wayne makes regular deposits and withdrawals to pay for Jack s pre-school expenses. Interest earned from the account is considered to be Wayne s. On the other hand, if the funds in the account are not excessive and are not used by any person other than the child, then the interest earned will be the child s interest. Shauna is aged eight and has a savings account in her name. Shauna s mother is a signatory to the account. The funds are birthday and Christmas presents from Shauna s relatives. Interest earned Rates and conditions as at 20 November 2014, and subject to change. Of the majors, NAB currently offers the best rate a standard interest rate of 1.0%, and a bonus rate of 2.73%, meaning a total rate potential of 3.73%. The Commonwealth s Youthsaver is the easiest account to open. If you have a login to NetBank and your child has a birth certificate, you can potentially open the account totally online you don t need to visit a branch. Some banks differentiate between under 12 s and over 12 s, allowing the latter to open the account in the child s name. Most provide an option for the child to be issued with a proprietary debit card like a Keycard. As usual, it may pay to shop around to find the account that suits you and your child/grandchild best. One final tip that came from a very helpful bank staff member. He volunteered that for his 13 year old daughter, he had opened two identical bonus saver 06

7 accounts linked together online. The first is used to accumulate the savings and he makes sure a deposit is made each month to get the bonus interest rate. The second is used a bit like a transaction account where small balances are held and any debits are made. Who said that you can t get great advice from a banker? Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances. Also in the Switzer Super Report: Peter Switzer Ignore the positive vibes at your peril James Dunn What to buy in 2015 Rudi Filapek-Vandyck Buy, sell, hold what the brokers say Penny Pryor Shortlisted Medibank, Woolworths and ANZ Staff Reporter Auction numbers hit high Brisbane shines 07

8 Investing for your kids or grandchildren Part 2 Key points Opening a share account for minors is getting harder which means, you have to open the account with a broker in your name, and effectively designate your child/grandchild as the beneficiary by placing their name in the account designation field. When your child turns 18, you should be able to complete an off-market transfer that changes the ownership legally to your adult child. Chose stocks that your child identifies with and are blue chips where they shop (Woolworths or Coles/Wesfarmers), where they bank (ANZ/CBA/NAB/Westpac), and their telecommunications provider (Telstra) are good places to start. In the lead up to Christmas, this is the second of 3 feature articles on how to invest for your kids or grandchildren. The other week, we covered how minors (people aged under 18) are taxed, whether your child needs a TFN (tax file number) or not, who is liable for paying any tax and we also reviewed some of the bank deposit accounts especially designed for kids. (For our first article, please click here.) Next week, we will focus on some of the special investment products insurance bonds and education funds. Today, we will look at how to buy shares for minors. Buying shares I am a big fan of buying shares for minors not because they might be the best performing investment (although they often are), but rather because I think the experience can be particularly educational and help foster a life-long interest in investing. All the evidence points to the sharemarket being a fantastic creator of long term, tax effective wealth, so I am often dismayed when adults explain why they haven t invested in shares. The biggest reasons I hear is a misplaced fear that investing in shares is like punting or gambling (which is fanned by an ignorant media), or I simply don t know how to do it. Interestingly, you never seem to hear these excuses about property. So, witnessing first hand the power of share marketing investing at a young age is a great way to overcome these barriers. Without banging this soapbox too loudly, I could almost develop an argument that every parent (subject to financial resources) has an obligation to get their kids to start investing in shares! Name recognition, that is choosing companies that your kids might associate with because they buy or use the companies products or services, is a big part of the story. The child s bank, supermarket where you shop, mobile phone provider etc can be good companies to start with in a portfolio, so that when the child gets the company s annual report and other correspondence, there will be some affinity with that company. And as a customer, they get to sample and evaluate first hand the offerings of the company they part own. Opening a share account for a minor Opening a share account for a minor is getting harder, mainly because the brokers have been 08

9 required to tighten their customer identification procedures. Further, many brokers have automated account opening and identification systems, which just don t allow an under 18 year old to operate an account. While there is no law that specifically says that shares cannot be owned by minors, some companies have a clause in their constitution that prohibits the registration of shares to minors. So, the ASX through CHESS, has adopted this convention and prohibits registration. This means that in the absence of a formal trust, you have to open the account with a broker in your name, and effectively designate your child/grandchild as the beneficiary by placing their name in the account designation field. The account will be set up, and shares registered, as follows: Frederick John Smith Parent/grandparent <Mary Jane Smith> Child/grandchild In law, you will be the legal owner, while the beneficial owner will be your child/grandchild. When your child turns 18, you should be able to complete an off-market transfer that changes the ownership legally to your adult child. As there will be no change of beneficial ownership, there shouldn t be any capital gains tax to pay. Which shares to buy? The starting point is to balance the size of the gift versus transaction costs (brokerage), then find some shares that are going to be good long-term performers. And hopefully, picking some companies that your child or grandchild will be able to identify with. The minimum order size that you can place on the ASX for an initial investment is $500. However, if you are paying brokerage of $19.95 or $29.95 this represents transaction costs of 4.0% or 6.0% respectively a pretty big chunk. So, I would suggest that you try to get the parcel size up to at least $1,000. diverse set of industries/sectors, and names that should be around in many years time. It is hard enough thinking about the market in the short term so thinking about the long term when there are going to be so many ups and downs probably leads to the conclusion that you stick to the major blue chip companies. If I was feeling particularly generous this Christmas and planning to gift $4,000, I would select: $1,000 of my child s bank (Commonwealth Bank) $1,000 of the company where we buy our groceries (Woolworths) $1,000 of a mining or resources company (probably BHP or Woodside) $1,000 of our telco/mobile phoned provider (Telstra) I make no claim that there is much investment science in the selection of this portfolio. However, there is some elementary diversification, they are companies my child should be able to identify with, I am confident that these companies are likely to be around in 10 years time and I have an expectation that they should be able to pay fully-franked dividends. CommSec s Share Packs Rather than do the hard work yourself, an alternative is to purchase a Share Pack from CommSec (some of you may remember these as the old Aussie Shares ). CommSec share packs are available in amounts from $4,000 (minimum) to $25,000 maximum. A very competitive fixed brokerage rate of $66 per share pack is charged for an online order. CommSec offers four categories of share packs: Capital Growth, Income, Market Leaders and Tax Effective Income. Each pack comprises six equally weighted companies, selected by the CommSec Research team. On Friday, a $5,000 Market Leaders share pack comprised the following stocks: CommSec Market Leaders Share Pack You also want to select stocks that come from a 09

10 Powered by TCPDF ( Also in the Switzer Super Report The Capital Growth pack was: CommSec Capital Growth Share Pack Paul Rickard: Investing for your kids or grandchildren Part 2 James Dunn: Companies to profit from falling oil prices Rudi Filapek-Vandyck: Buy, Sell, Hold what the brokers say Penny Pryor: Shortlisted Murray recommendations and retail stocks Mark Ellem: SuperStream Is your SMSF ready? Staff Reporter: Growth moves beyond Sydney and Melbourne These pre-mixed alternatives are easy to buy, cost effective and arguably, have a stronger element of diversification. While I can t readily see how Stockland qualifies under the capital growth label, let s assume that there is some science in their construction. The downside with these packs is that the name recognition may not be as high. Whether you use these pre-made packs from CommSec or do the hard work yourself and select one or more shares, in the long term, I am sure that your child or grandchild will appreciate any gift of shares no matter how large or small. Just don t expect rapturous applause on Christmas morning! Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances. Follow the Switzer Super Report on Twitter 10