investment for kids | 6 ways to invest for your kids
Every parent wants their kids to do better financially than they did, and as a result many are looking to invest on behalf of their kids! There’s a few ways to go about it, and there’s varying advantages and disadvantages to each approach. Glen James has gathered 6 options together for you to consider, read on!
Check out these podcast episodes on my millennial money where Glen outlines everything you need to know about these investment options:
6 ways to invest for your kids
Here are the 6 options you can consider when investing on behalf of your kids:
in your own name
in an Informal Trust
in an investment or education bond
in superannuation
in a Formal Trust / Special Disability Trust / Testamentary Trust
in experiences
Throughout this blog the term ‘minor’ will be used to refer to children under the age of 18 years.
#1 in your own name
You can set up a dedicated account with a bank, on an investment platform, offset account (separate), share brokerage account or just continue to build wealth in your own name. No mention of the minor is required.
How the tax side of things works:
Any income is taxed in your tax return at your marginal tax rate
No Tax File Number (TFN) is needed for the minor
Franking credits/foreign income tax offsets are available for you to claim in your personal tax return.
Capital Gains Tax (CGT):
You carry this on your tax return at your own marginal tax rate
The CGT discount is available where the shares/investment is held for longer than 12 months
The advantages:
It’s flexible and low hassle
You can use funds for anything that might come up (they don’t need to be ‘quarantined’ for use for/by the minor)
Disadvantages:
Transferring shares and assets to the minor will attract CGT as a beneficial change of ownership will occur. This does not occur with cash.
Estate planning will need to be considered to ensure any wishes are noted, otherwise the money ‘flagged for minors’ may go directly to your spouse or other parties.
Other considerations:
Consider the tax benefits of the account being held in the lower income earning spouse’s name or a joint account.
You can also use this strategy with a bank account dedicated to the minor. You may choose to open a dedicated bank account in your name for the benefit of the minor. This is a notional dedication for ease of your own admin.
If you’re investing for your grandkids and you’re approaching age pension eligibility, check gifting rules and asset limits.
If you’re contributing significant amounts to the bank account/investment, be aware of the impact on family means testing if you’re receiving allowances or financial support through Centrelink.
Consider taking the approach of paying down your own mortgage with extra repayments (such as in a redraw or offset) and gifting money in the future if desired.
#2 informal trust
Informal trust accounts are set up to have a designation to the minor. The bank account, investment platform or brokerage account will have your name and then the minor’s name. An example might be ‘YOUR NAME <MINOR'S NAME A/C>’.
There is no trust deed or dedicated bank account for the trust as it’s informal with the account holder or parent (over 18 years old) controlling the money for the benefit of the minor. This can also be a bank account dedicated to the minor.
How the tax side of things works:
A TFN is needed for the minor
Income is taxed at high minor rates
If the income each year is over $416 or you wish to claim franking credits (or other credits such as foreign income tax offsets), a tax return will need to be filed.
CGT:
CGT will fall on the minor’s TFN.
CGT discounts are available where the shares/investment is held for more than 12 months.
Advantages:
Having a dedicated account for a minor could prevent you from spending it.
The cost base of the shares/investment does not change (or trigger a CGT event) when a minor turns 18 and the funds are transferred to their own name.
It’s a low cost investment option if using an index ETF via a brokerage account.
It’s a great way to engage with the minor and have them contribute their own income when they start working.
Disadvantages:
The cost or hassle to do a tax return for the minor each year
A potentially higher tax rate than the adult
More paperwork involved
It may cause issues if you start using the money (whether that be for your own purposes such as paying rent or buying groceries, even if you ‘replace’ the money, or for purposes such as school fees for the minor) as it could be considered an expense for the adult as it’s not an education bond (this effectively could mess with the cost base for CGT when transferring to the child’s name when turning 18).
Adding conditions to the child accessing the funds (i.e. achieving a goal/milestone such as graduating university) may also impact who is considered to be in control of the funds (and therefore who is taxed on the earnings).
Other considerations:
This option is the murkiest option in terms of Australian Taxation Office (ATO) guidance.
Consider high growth and low yield investments to minimise dividend income.
It would be considered best practice to create a TFN for the minor and add it to the bank account, brokerage account or investment platform (where possible). This will create a stronger link for an informal trust arrangement.
Many ‘minor investment accounts’ linked to popular investing platforms do not ask for the TFN of the minor and while it’s set up as an informal trust the income is often declared on the adult’s tax return. This may not be ideal and speaks to the confusion and complexity of the matter with information available from the ATO and trust law in general.
If the adult trustee’s TFN needs to be quoted, the income should still be declared on the minor’s income tax return.
It may be prudent for an informal trust arrangement to be in place when the adult’s income is in the highest marginal tax bracket.
#3 investment bond (including education bond)
This technically falls under the life insurance category and is formerly called insurance bonds. This is purchased in the adults name (parent, aunt/uncle, grandparent) and sits outside all of their own affairs as it’s internally taxed.
The adult would elect a minor as a beneficiary and this is non-binding. The adult owner may also list that it’s their intention for the money to be used for a house deposit, after age 25. This note will be on file should the adult die prematurely.
How the tax side of things works:
It’s internally taxed within the bond at company tax rates (maximum tax is 30%)
Tax could be well less than 30% due to internal franking credits of the investments
There’s no need to put this on the owner’s income tax return.
CGT:
If the bond is held for over 10 years, withdrawals are generally tax free to the beneficiary.
Advantages:
It’s a one-stop-shop – it’s basically an automated investment platform.
It’s out of sight out of mind – dedicated to the minor.
There’s no need to add it to any income tax return and the minor does not need a TFN.
It falls outside of one’s estate which is good for estate planning.
Many providers have a variety of investment options.
If you change your mind, you can remove the minor as a beneficiary (it becomes your bond).
Disadvantages:
It may not be seen as tax efficient as other options due to lack of CGT discount internally in the account (dependent on investment).
Can only add 125% of previous year to the account each year. A second bond can be added though if you wish to add a higher amount as over a 125% contribution of the previous year will reset the 10-year rule.
Higher cost than say, direct brokerage, but you pay for convenience.
Other considerations:
It could be the most appropriate option for aunts/uncles and grandparents.
Consider your annual transfers against the initial capital.
Other members of the family can also contribute with ease providing the 125% rule is considered.
Education bonds:
Basically the same as above however tax is rebated when money is used for education costs, uniforms, travel, living away from home expenses etc. Consult an investment bond provider for specific product options.
#4 superannuation
There is no mention in superannuation law that there is a minimum age requirement for a retirement savings account to be opened. Money can be contributed as after tax non-concessional contributions. This would fall in line with the concessional and non-concessional contributions caps of the day.
A parent would need to open a superannuation account on behalf of the minor. Some super funds might not offer this option. In the case of a Self Managed Super Fund (SMSF), the deed would need to specifically allow those under legal disabilities (which is what a minor is considered to be) to be members and make contributions.
The super fund would be in the minor’s direct name and a date of birth would be provided, along with a TFN. A TFN is not required but best practice to set one up.
How the tax side of things works:
Taxed internally at the superannuation rate of 15%.
CGT:
Superannuation trusts receive a 33.33% discount for CGT.
Advantages:
It’s the most effective long-term investment available due to the money growing in a tax effective environment.
Money could be used for the First Home Super Saver (FHSS) scheme in the future.
Easy for parents, grandparents and aunts/uncles to contribute money to.
There’s no need for any information on the parents tax return nor is a tax return for the minor needed.
Disadvantages:
Legislative risk. Rules may change over the long-term (contribution caps, preservation age, taxation rates etc).
The money is not available for anything other than a condition of release (attaining preservation age – currently age 60, disability, FHSS scheme, compassionate grounds etc).
The minor may not be as engaged with learning about their investments due to the ultra-long time horizon.
Low balances may have a disproportionate impact from fees etc, eating into the capital base of the account.
Other considerations:
This may only be used for high net worth families or for future asset protection.
Fees may be higher for a superannuation account than a brokerage account but the tax savings may offset this fee.
#5 formal trust
This involves a formal trust set up with a trust deed drafted by a lawyer. This would list the minor as a primary beneficiary and perhaps other considerations for the use of the money. The trust will likely need a TFN and bank account. The investment platform, brokerage account or bank account would be set up in the name of the trust. An actual person or corporate trustee company (with an adult as director) would control the trust as per the trust deed.
This is basically the same as a discretionary family trust.
How the tax side of things works:
A TFN and likely an ABN will be needed for the trust.
Trust’s don’t pay tax so money would need to be distributed to the primary beneficiary (the minor) and taxed at the minor’s tax rate.
This would require the minor to have a TFN, too.
CGT:
This would flow through to the minor AKA the beneficiary, who would be taxed at their marginal tax rates.
Advantages:
It’s a separate dedicated entity
It does not need to be transferred when the minor turns 18 as they would just become an adult beneficiary and the income is taxed at adult tax rates.
Disadvantages:
It’s complex with lots of admin (may need bookkeeping software)
It would need annual tax returns for the trust and also the beneficiary (the minor).
There are sigh setup costs for drafting trust deed
It can have significant tax implications if not done correctly (undistributed income taxed in the trustee’s hands, family trust elections etc).
Other considerations:
This may be reserved for high or ultra-high net worth individuals and families. It may also fall into broader estate planning discussions.
#6 investing in experiences
Forget feeding kids fish. Show them how to catch fish! Many people are now deciding rather than providing amazing money for their kids as a gift, to spend that money on family experiences. This could be annual holidays overseas, around Australia or monthly activities. It could also be after school sports or learning another language or instrument. You may set up another bank account or offset account dedicated to family experiences.
How the tax side of things works:
It’s your money so it’s taxed at your own tax rates.
CGT:
There’s no asset other than cash and cash does not attract CGT.
Advantages:
You’re building resilience and life experiences in your children.
Your child can learn that the hard work and good financial stewardship from parents have afforded the family to do this activity.
It can lead to lots of family time to grow together and memories made.
Disadvantages:
No hard dollars invested to grow for the future.
You may have to cash flow any education expenses.
There’s a risk of kids becoming entitled brats if they miss out on education around money, what a dollar is worth and privilege.
Other considerations
You may choose to set up a small investing account in your own name for the child with superficial financial amounts to teach your children about investing.
Have the kids buy into various experiences, for example, ‘You are responsible for helping research three options online of museums to visit in Rome’.
What about Capital Gains Tax (CGT)?
When it comes to Capital Gains Tax (CGT), generally speaking it comes down to who is the beneficial owner. In almost every case, if there is a change to the beneficial owner of an asset, this triggers a disposal. For property, this can also trigger stamp duty to be paid again (i.e. selling or gifting a house to another family member).
An example
You have an informal trust arrangement with the child’s name in the account designation. You reinvest the dividends and the money is for your child to do as they wish when they turn 18 (it is not utilised by the parents at all in the interim, even in relation to expenses for the child). Each year you do a tax return for the child. At age 18 when transferred to the child, there is no change in beneficial ownership as the money was always intended for the child and not used for anything else, so this does not trigger any CGT event nor is there a disposal of the asset. The cost base remains the same. Your investment platform may do an in-specie transfer to the new account name (the now adult).
The fine print
Key details to understand when investing for minor.
Tax rates (excluding Medicare Levy)
Unearned income (effectively ATO talk for passive income and not eligible for offsets) of minors
$0 - $416 - NIL
$417 - $1,307 - 66%
Over $1,307 - 45%
If a minor earns more than $416 per year,a tax return is required. Example of earnings based on investment amounts.
$5,000 earning 6% per year invested is $300
$10,000 earning 6% per year invested is $600
Excepted income
Is taxed at normal adult tax rates (exempt from high minor tax rates and can receive offsets etc)*
Income from job
Income from testamentary trust
Damages from personal injury
*and other limited circumstances
Excepted person
All income taxed at adult rates, regardless of source
Works full time or at least three months of financial year
Principal beneficiary of special disability trust*
* and other limited circumstances
General Comments
Australia does not have any rules or caps on gifting of cash or assets within taxation law, like other countries do. It is solely up to the individual as to what is gifted to another person or entity. There may however be rules around gifting under other legislation, such as government benefits or state-based stamp duty may be payable (i.e. gifting a property).
This discussion does not directly address gifting upon death (i.e. bequeathment of funds or assets in a Will), and it should be noted that such occasions can have very different tax implications than what is discussed here.
Remember, for those those on social security - check with Centrelink on the impact of the above options.
We assume in this discussion that all individuals and entities are Australian tax residents - if your circumstances include foreign tax residency, this discussion may not be applicable to you as the tax implications in respect of tax residency can be very different to what is discussed here.
Learn more at these links below:
Frequently Asked Questions
Q: What if I invest for the child in an informal trust and use the dividends myself?
A: This would also potentially cause issues with CGT when transferring the account to the minor’s name when they turn 18.This income would also likely need to be declared on your income tax return as you have used the money, it has not been kept for the benefit of the minor. This is one reason why you need to be very careful with your intentions (and that your actions along the way match those intentions) when setting up these arrangements.
Q: Can I have a joint account for my two kids?
A: Yes, however, this would generally be in your own name, not an informal trust. A formal trust could be set up with both kids as a beneficiary.
Q: What investing platforms allow you to set up investing for your kids?
Some common options where you might already be investing include Raiz Kids, Vanguard Personal Investor Kids, SelfWealth investing for kids, Pearler Headstart, Minor Account with Superhero, Stockspot investing for kids. Read their product disclosure statements before signing up. Most, if not all, will require a parent master account.
Q: How can you invest for someone else’s kids? For example, for your god children, or for your friends or sibling’s kids?
If it’s once off, you can give the money to the parent to invest for the child if they have an informal trust setup. If it’s ongoing or a significant amount an investment bond may be useful in this instance with the minor as the beneficiary.
Q: What happens with the investments if you (adult) pass away prematurely?
This all has to do with the ownership of the investment and the type of investment. This is why it’s important to consider estate planning when setting up investments for minors. This is how investments would be handled across the 6 options:
Invested in own name
Money goes to the estate and is distributed as per the will. If it’s in joint names with a spouse, it will revert to the spouse automatically. Do check with your platform or registry to confirm they treat joint accounts as ‘joint tenants’ (automatically reverts to surviving spouse) or as ‘tenants in common’ (spouse share reverts to their estate). There may be options to change this arrangement with the platform you choose.
Informal trust arrangement
If there is an informal trust arrangement and the parent dies, their estate / legal representative would become the trustee until a suitable trustee can be found. The money doesn’t automatically go to the minor, it is still held on trust for the minor albeit informally.
Investment bond
These fall outside of one's estate and are directed as per the beneficiary of the bond. These are not governed by one’s will.
Superannuation
Superannuation also falls outside of one's estate. A beneficiary can be named and failing that, the superannuation trustee will use discretion as to where the money is to be paid to. A superannuation fund needs to be wound up when the member dies. There can be a number of significantly different tax outcomes upon the distribution of superannuation and so specialist advice is recommended in this instance (preferably before death!).
Formal trust
If you have a formal trust arrangement, you need to ensure your broader estate planning is sorted. A trust is controlled by a trustee. Many trusts established have a corporate trustee (it’s best practice) which is a company. The shares and directorship will be held by the adult. So in practice, if an adult passess away the administrator of their estate would control the trust and form a suitable solution going forward (this would likely also be the case for individual trustees rather than a company). It is important to get specific advice where a formal trust is involved as more than just the Will needs to be considered – the trust deed and the company’s constitution also have an impact on what happens after death.
Q: Can I get a tax deduction for contributing to a savings account or investment for my children?
A: No, this is not possible. However, if you are going to be taxed on the income, and you incur costs in relation to that income (e.g. bank or account keeping fees), you can claim a tax deduction for those costs.
Q: Can I do multiple options – i.e. an informal trust for shares, and an account in my own name for cash?
A: Yes, you can. However, it goes back to ease of administration. What is easy to manage for some is annoying for others. One strategy could be you have shares for the minor in an informal trust arrangement and a notional account in your name (not an informal trust) that you can use at your discretion for education, experiences etc. The interest income will fall on the adult's tax return. This is no different to having an account you use to save for family holidays for example.
Q: What happens if I set up a bank account or share investment for my kids, and then change my mind before they reach age 18 and decide to keep it in my own name?
A: This is not an issue if it’s just in your own name. However, in the case of an informal trust having been set up, then an informal trust is the same as a formal trust in that the asset is considered disposed of by the trust. Consequential tax impacts whomever is considered to be the beneficial owner at the time (assumed to be the minor, if the informal trust is set up and treated appropriately).
Q: What happens if my spouse and I set up a bank account, share investment for our kids in our joint names (or in a formal trust), and then we get divorced (before the kids reach age 18)?
A: Don’t get married or have kids. If it’s in joint names (not an informal trust), it becomes property for a divorce settlement. If it’s a formal trust, the status quo would remain and you would likely continue to be trustees (or directors of the corporate trustee company) if this was a desire. Otherwise, one parent may become a sole trustee or director of the corporate trustee company. There are laws in Australia that can hold trustees to account if they are not acting within the trust teed of a trust.
Q: Do I need to update my will with details of the arrangements?
A: It would be considered best practice to do so and note your intentions., i.e. you have an informal trust set up for a minor and the intention is for this money to be used for a first home deposit or broadening their life experiences with travel when they turn 25-years-old, for example. You may also have money in your own name or have contributed extra to the mortgage. Your intentions should be noted in your will, in concert with your partner’s will and the broader estate planning considerations.
Teaching your kids about money
When it comes to giving kids the skills they need to manage money, nothing is more effective than parents taking the time to talk, explain and show kids how it all works. Whilst it would be incredible to see more education provided through the schooling system, ultimately the most effective teaching happens when parents have money conversations and work with their kids to learn and grow in money-management skills. These conversations start at a basic level and build in complexity as they get older, and ultimately earn and manage money for themselves.
Here are some great ways to do this with your kids:
Conversation and modelling
We ran an informal survey with parents in our community and discovered that most parents find conversation and modelling to be the most effective way to teach their kids about managing money. A lot of this comes down to you knowing your kids better than anyone! What helps them learn? What really gets their attention? What do they resonate with? Where previous generations may not have wanted to talk about money, start changing the culture and talk about money with your kids.
Talk about and show them concepts like:
Spend less than you earn – show them what money comes in and out each week.
Give every dollar a job – show them what you spend money on and why.
When you go to pay a bill, ask your kids to join you in the process.
Teach them about what you want vs what you need – explain what items in your expenses are mandatory, and what’s just nice to have.
Talk about saving and investing money for the future! Show them how you save and invest.
Show them how much things cost, and how long it would take to save for those things.
Teach them about compound interest with the activities in our blog.
When they’re ready explain the difference between paying for things with money you have vs debt.
Allowances
Parents sit in different camps when it comes to allowances for their kids, so customise this to your kids and family culture.
Some parents choose to pay an allowance for doing chores at home – consider if you’d like to do this,
OR
pay an allowance for jobs they do above and beyond basic chores. Also encourage them to do paid and unpaid jobs for others outside of your home – friends, family, neighbours.
Whichever way you choose to go, teach them about spending, saving, investing and giving with the money they earn/are given.
Match savings
Another way to teach kids about building savings in particular is to match their savings. This might be an approach to take with an older child who understands the concept of saving money well. Sit down together and allocate a savings target, even if it’s just $100 to start with. If they’re able to reach that target, match that savings amount by adding $100 to their savings account yourself, as an incentive to keep saving. Increase the amount from there, and use this exercise to show how savings come together and how ultimately the money can be used for their goals.
Teaching kids about generosity
Generosity is also a really key aspect of how our money can not only build our wealth, but support people and organisations in our communities. Here are some ways you can teach kids about the importance of generosity:
Show them the charities or projects you support (with finances or time) and why
Help your kids identify what causes they might like to support
Share how you can be generous with your time as well – offer to help a friend or a cause that needs volunteers
Talk about how different everyone’s financial situations are – some families earn less or more than you, some are affected by things like illness or misfortune out of their control.
