With Christmas approaching, the idea of investing for your kids or grandchildren may be something you have been considering. While it’s unlikely to produce the same “under-the tree” reaction as the latest hot toy, 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 investment.
In this article, I look at taxation issues including applying for a TFN, road test kids’ bank accounts and buying shares, and my personal favourite and probably the easiest way to invest, insurance bonds.
- 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 $500 in interest, then tax of $55 will be payable ((0.0 x $416) + (0.66 x $84)) = $55.
When it comes to income on fully franked shares, both the dividend in cash and the franking credits are included as unearned income. Your child or grandchild will also get the benefit of the franking credits, which are applied for a second time to act as a tax offset. Putting these together, if we assume an average fully franked dividend yield of 4%, this means that your child/grandchild can have a share portfolio of $13,346 before paying any tax. Under this size, they will be eligible for a refund in cash of all or part of the franking credits.
Does your child need a TFN?
There’s 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 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’re 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. If they are under 12, you will be required to sign the application (and provide your identification documents).
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 (grandparent) owns the money if they provided the money and they spend it as they like, irrespective of whether 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 Jack by depositing $5,000. Wayne is a signatory to the account because Jack is 4 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 8 and has a savings account in her name. Shauna’s mother is a signatory to the account. The funds (totalling $90) are birthday, and Christmas presents from Shauna’s relatives. Interest earned from the account is considered to be Shauna’s.”
- Kids’ 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 up to 3.50% provided one deposit is made per month (usually no size requirements) and no withdrawals are made. All the accounts are fee free for minors.
CBA, NAB and Westpac offer the highest potential interest rate of 5% pa. To qualify for the full 5%, one deposit must be made each month, and the balance must be higher at the end of the month. If a withdrawal is made or the balance doesn’t grow, the interest rate reverts to the standard rate, which in NAB’s case is only 0.35% pa. CBA has the highest standard or base rate of 2.60% with its Youthsaver account.
ANZ also offers ANZ Plus, its new digital only account, which pays interest at a rate of 5.00% on amounts up to $5,000, and 2% for each dollar over $5,000. The “child” must be 15 years or older.
Account opening requirements vary. If the child is over 14, most banks allow the child to open it, and it will be held in the child’s name. Under 12 will require a parent to open the account, and while some banks title the account in the child’s name, others use a trust structure. Parental controls are available. 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 helpful bank staff member. She volunteered that for her 13 year old daughter, she opened two identical bonus saver accounts – linked together online. The first is used to accumulate savings (she 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 cannot get great advice from a Banker?
- Buying shares
I’m a big fan of buying shares for minors because I think the experience can be particularly educational and help foster a life-long interest in investing.
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, the 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 greater affinity. And as a customer, they get to sample and evaluate first-hand the services of the company they part own.
Opening a share account for a minor
Opening a share account for a minor is getting harder because the brokers have been 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 to operate.
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 direct registration to minors.
This means that in the absence of a formal trust, you have to open the account 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 A/C> Child/grandchild
In the legal sense, you’ll 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 vs transaction costs (brokerage) and finding 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.
You also want to select stocks that come from a 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 where there are going to be so many up and downs probably leads to the conclusion that you stick to the major blue chip companies.
If I were feeling particularly generous this Christmas and planning to gift $5,000, I would select:
$1,000 of my child’s bank (e.g. Commonwealth Bank)
$1,000 of the company where we buy our groceries (e.g. Coles or Woolworths)
$1,000 of a mining or resources company (probably BHP)
$1,000 of a telco or major online business that they may experience (e.g. Telstra, Seek etc.)
$1,000 of a major health care company (probably CSL or Cochlear)
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 (in most cases) fully franked dividends.
There are also micro-investing apps such as CommSec Pocket or Raiz, where you can invest as little as $50 typically into an ETF (exchange traded fund) that passively tracks an index. However, both apps have a condition that the person opening the account must be 18 years of age or older. (Raiz offers a ‘Raiz Kids account’ once you are a customer).
If you do buy shares for your child or grandchild, I am sure that one day they will appreciate the gift – no matter how large or small. Just don’t expect rapturous applause on Christmas morning!
- Insurance bonds
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 (e.g. ‘Australian shares’) or multiple asset classes (e.g. ‘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 9th or 10th 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 125% 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 2 and a further $1,562.50 in year 3 and have, for tax purposes, the same 10 year term expiry being the 10th 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 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 (or companies who leverage a life insurer). Five of the major issuers and details of their bonds are detailed below:
Pros & 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. Downsides are the management fee, buy/sell spreads and unlike direct shares, an insurance bond may not be quite as effective in helping your child or grandchild 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.
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.
