Investing for your child’s future is a smart move that doesn’t just make it easier to manage future costs; it can also spark your youngster’s own interest in wealth creation.
Let’s take a look at some of the strategies available.
A dedicated savings account
It’s common for families to open a savings account for a child and steadily tuck cash away for their future. It’s a well-meaning gesture but it can be the slow road to success. Cash-based investments are very safe but the returns are extremely low, and some junior savings accounts have strings attached before a decent interest rate applies that make the savings journey even slower.
That said, opening a savings for your child can be a great way to teach basic lessons around the value of regular saving.
It’s also important to remember that unearned income received by children can be taxed at punishing rates – take a look at the table below. If you’re regularly dipping into the account yourself, the Tax Office could regard you as the true account holder and include any interest earnings in your own taxable income.
Tax rates for children (under 18) 2017/18
Tax rates for 2017–18 income year
$0 – $416
$417 – $1,307
Nil plus 66% of the excess over $416
45% of the total amount of income
Source: Australia Taxation Office1
Education savings plans (ESPs)
As the cost of education rises, it’s natural for parents to think about how they’ll manage this expense, and an education savings plan (sometimes known as “scholarship plans”) can offer a solution.
These plans allow parents, grandparents and other relatives to contribute cash towards a child’s education. The money is pooled with contributions from other families, and earnings on the underlying investments are taxed at the corporate rate (currently 30%). When money is drawn out of the plan to pay for school costs, the plan claims back the tax paid on investment earnings, and this tax benefit is passed on to parents, meaning more of your money goes to covering education expenses rather than being pocketed by the tax man. This tax saving can be especially useful for high income earners.
On the downside, plan providers charge fees, and be aware, if you are saving for, say, tertiary education costs, and your child decides not to pursue higher education, you may only receive a return of your capital – not the income this money has earned. If you’re keen on using an education plan, contact your local financial adviser to discuss if this could be the right option for your situation.
Insurance bonds are quite distinct from insurance in the regular sense of the word, however they are issued by some of the large insurance companies (plus other financial institutions), and this may explain the name.
The investment income earned on insurance bonds (also known as “investment bonds”) is taxed at 30% and paid by the investment company. If an investor holds the bond for at least 10 years the earnings are returned to the investor “tax paid”, which is a plus if your personal marginal tax rate is above 30%.
This 10-year timeframe means that parents hoping to maximise the tax benefits of insurance bonds need to start investing at least a decade before the cash will be needed. As a plus, insurance bonds generally come with a range of underlying investment options – from conservative to high growth. There are some conditions around the maximum amount you can contribute each year, so it is important to check with our office to see if this could be an appropriate strategy for your situation.
Managed funds work by pooling the cash contributed by a large range of unitholders, and investing it in a variety of asset classes depending on the individual fund’s approach. Some funds focus on Australian shares for instance, while others are more diversified, spreading the underlying cash across a variety of investment classes or global markets.
No particular tax benefits apply to managed funds in the way they do for insurance bonds or education savings plans. However, parents are not bound by any investment timeframe or the need to use their investment to meet specific costs such as education expenses. With the benefit of professional management, managed funds can be a low fuss way to invest, though do watch out for fund fees.
Directly held shares
Quality shares can provide ongoing dividend income plus long term capital growth. And starting your child with a small portfolio of shares can encourage their own interest in investing.
However, as experienced investors know, sharemarkets can be volatile, and it’s important to speak to me about whether shares – and if so, which ones - are best suited for your child’s portfolio.
A family trust is not an investment in itself but rather a vehicle to store your assets. They offer a way of reducing the tax payable on investments by spreading the returns across the entire family, thereby reducing the overall tax bill.
This may sound like a great idea but trusts can be complex and there are costs associated with establishing and running a trust. Our financial adviser can let you know if a trust might be suitable for your family situation.
If you would like to put a plan in place to help support your children’s financial future, contact your FinChoice Financial Adviser and they can put a tailored plan in place on the most appropriate way you can invest to meet the needs of your child and your family.
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1 Higher tax rates 2017, Australian Taxation Office, https://www.ato.gov.au/Individuals/Investing/In-detail/Children-and-under-18s/Your-income-if-you-are-under-18-years-old/?page=3