Have thought about investing for your children yet?
As I sat in the parent's room at the hospital watching the planes come and go while looking after our newborn daughter as my wife caught up on some much-needed sleep, it got me thinking what the world would look like when both our girls are grown up.
We are living in the middle of a pandemic and at the same time seeing growth rates in the price of properties flying so high it's hard to imagine that either of our children will ever be able to afford a place of their own in the future. I mean, I'm looking at houses right under the flight path currently on the market for upwards of $800k. That's ten times the average salary based on the ABS average income statistics, and back in 2010, it was only averaging around 6.8 times the average salary. With this type of growth happening, what kind of earnings to price will we be leaving for our children, and where will they get a deposit?
The very best thing we can do for our children is to start investing early for them and help teach them about investing and the benefits of compound interest. It still surprises me today that budgeting and investing are not subjects taught in school as it is undoubtedly a life skill that everyone should have.
If you start when they are young
Below I discuss a few options for starting early with investing for your kids, which will help determine which avenue is most appropriate to your circumstances or get you thinking about investing for your kids and seeking help setting something up for them.
I have already taken the liberty of acknowledging that all these investment structures are long-term investments. Hopefully, you know that investing is never a short term time frame and money needs to be invested long term to minimise market volatility risks.
Setting up an investment account in their name or your name
If you want to look at buying direct shares or investing in Managed Funds / Exchange Traded Fund’s (ETF’s) for your child in Australia, it is vital to determine in what name the investments will be held as different tax rates need to be considered.
If you decide to purchase the investments directly in your child's name, then any capital gains or dividend payments above $416 per annum (2021-21 financial year) are taxed up to a tax rate as high as 66%. This is the case because wealthy individuals utilised their child’s tax-free threshold and reduced their tax rate in the past.
Then there is the option of purchasing the investment in your name. This will mean that any capital gains or dividend payments will be included in your tax return and subject to your individual marginal tax rate. With this approach, you can transfer the investment into your child’s name at a point of time in the future through an off-market transfer. There is usually just a small fee to complete this.
Finally, you could open an account where you are acting as the trustee for your child. The best thing about this setup is that when your child turns 18, the shares can be transferred to their own name, and since there is no beneficial change of ownership, there will be no capital gains tax.
Investment / Insurance Bond
An Investment bond for your child is essentially a tax environment where the earnings are taxed at the company tax rate internally rather than having to be included in your personal tax returns. You are given this benefit as you will need to forgo access to these funds for a minimum of 10 years to avoid any penalties.
How it works is that you are the owner of the investment bond, and you can have your child nominated as the beneficiary. At a certain point (usually after your child is 16), the investment bond can be transferred to your child without triggering a capital gains event. After ten years, the additional benefit is that if they choose to sell down the investments and withdraw the investment bond, there are no capital gains to pay.
It is a structure where you get access to several managed funds to invest the money depending on the amount of risk you are prepared to take. There is also the ability to make regular investments each year as long as you do not exceed 125% of the previous year's contributions.
An investment bond is also not included in the estate upon the parent's death and is passed directly to the child.
A more suitable structure may be a family / discretionary trust if you have multiple children with multiple investments. A trust allows flexibility of investments and how the funds are distributed; however, as discussed before, any income distributed to your children over $416 per annum will be taxed at the highest marginal tax rate.
However, you can hold an asset under a fixed sub-trust (only if the trust deed allows it) where any income is distributed to others, and the child gets to receive all capital appreciation until the child reaches age 18.
This type of structure would require more objectives than just wanting to invest for your kids to make it a viable option as there are additional initial setup costs and ongoing administration and costs.
Giving your kids a helping hand to buy their first home
If you did not start investing early enough (or not) and want to help your children enter the property market, there are still options.
Bank of Mum and Dad
Nowadays, it is becoming more and more common for children to not only stay living at home much longer than they used to but now actually rely on a leg up from the bank of mum and dad to secure their first home. Many statistics show that nearly 80% of first home buyers receive some financial help from their parents for their deposit.
Another form of financial help first-time homebuyers can receive when purchasing their first home is for their parents to act as guarantors for the loan. This certainly has its advantages for the first home buyer, such as removing the lender's mortgage insurance; however, there is a disadvantage to the parents that are not always adequately discussed. Once they become guarantors, the equity they have built up in their own home is essentially the security for the new home. This means that they are limited on what they can do.
For example, depending on their circumstances, they would not be able to use the equity to purchase an investment property or investment portfolio. In a lot of cases, they are also not able to sell the house. Parents need to be entirely sure of their future financial plans before going down the road of being a guarantor for their child.
One of the most significant intergenerational wealth shifts is about to happen, with the baby boomer generation entering retirement and looking to leave their hard-earned money to their children when they pass. Unfortunately for many children, this will not happen when they want to buy a property, and by the time their parents pass, they are usually parents themselves. This is because people are just living longer now and require more money to get them through retirement.
For an inheritance to start playing a big part in giving kids the ability to buy their first home, we need to start thinking differently about who will get your money when you pass away. Traditionally, your money is passed to your kids; however, I see it as more beneficial with the shift in ages these days if you have grandkids to bypass your children’s generation and leave your money directly to your grandkids.
This is because statistically speaking, the average lifespan is 80+ which if you had been an average person and had the average size family of 2.5 kids and you had your first kid at 25, and your kids are the also average people then by the time you pass away your grandkids are at a position of their lives where traditionally your children would have been. It is at this stage of life they could use the money for a deposit for a house.
I have not gone into details about what type of investments you could invest in. The most important thing is to start investing in the proper structure that best fits your family’s particular circumstances. If you get this wrong initially, it could cost you more than picking the wrong investment.
When you are looking to start investing for your children, you need to ensure your own finances are in order. There is no point in starting to invest for your kids when you are carrying credit card debt of over 19% or a large car loan. You need to ensure that you have paid down all your bad debt and have an emergency fund set up. You also want to have your safety net of insurances in place because if you implement a plan of investing for your children and something happens to you, what do you think happens to that plan!
If you would like to discuss the options in more detail and receive advice that directly suits your particular circumstances, please contact our office to request a free 90-minute consultation. Click Here to have someone call you and arrange a time that is convenient.
Terrell Hyman the Director and Principal Advisor at Trl Financial Solutions.