“I have 4 grandchildren that are yet to start primary school and I would like to invest some money to help with their tertiary education. Is there a low-cost way to do this?”
- Question from Josephine in Adelaide
Top answer provided by:
Andy Darroch
Hi Josephine,
Firstly, that’s fantastic, investing for your grandkids provides not just financial benefits, but can help to educate them about money, which, without sounding too much like a knob, is perhaps the most valuable element.
Put simply, yes there is. There are three common avenues people take. That said, there’s one which in my opinion is better than the rest.
Now a key element in all of this, is how much, for these purposes I’m going to assume the initial investment we’re considering is lower than $25,000.
Other than the amount, there are two key considerations:
- Where to invest the money (in whose name); and
- How to invest the money (what to buy).
Considering no one has started school, we’ve got an investment timeframe of at least 12 years. Regarding, where i.e., “who”, what structure, the key consideration is tax, but another consideration is social security (meaning the age pension).
The original answer, an “Investment Bond” (not the best)
The traditional answer from advisers has typically been an “Investment Bond”. An investment bond is something in between superannuation, a life insurance policy, and a managed fund. They are marketed as being a good solution for exactly this. Except they’re not.
Investment bonds typically have high fees, below-average managers, a limited menu and are becoming less and less common. Stockspot did some research and found that in the 5 years to December 2020, the average investment bond returned 4.7% per annum, when a comparable ETF did 10.4% per annum. That’s pretty rubbish. They’re also complex, you typically need to pay an adviser to help you set them up and they don’t leave much flexibility. They’re only really useful when someone’s tax rate is more than 30% (think a Parent – not a grandparent).
With investment bonds, their best days are long behind them, whatever you might theoretically save on tax (if you’ve got a high MTR), you’ll quite likely forgo more in poor investment performance. So let’s strike investment bonds and leave them where they belong back in the ’90s.
Common answer, “Investing for the kids with an adult as trustee" (not the best)
You’ll hear a lot of diverging things with this one, it's not well understood by advisers or clients. In this scenario, sometimes people think that the tax is paid by the children, and other times they think it’s paid by the adult (“trustee”). The idea is because no one under 18 can open an investment account, that the grandparent (trustee), does so on the child’s (minor’s) behalf. The problem with this is that any investment income above for minors (anyone under age 18) is taxed either at 66% or at 47%. Yes, you read that right. The reason is simple, the tax office doesn’t want people removing tax by setting up share portfolios in their kid’s names that are owned and controlled by someone else. Secondly, you’re going to have to set up a bank account for the child, apply for a TFN, and complete a tax return every year. Any administration for the account will be a pain with you signing on behalf of the child. And you’d better make sure you never use any of the proceeds yourself. It’s a fairly intense process just to pay tax between 66% and 47%. The benefit? Well, say you invest for 12 years, then at the end, the kid turns 18, and bang, they’ve got normal tax rates, and, importantly, you don’t need to sell anything and it’s already in their name. However, these funds are for tertiary education (or something you deem appropriate e.g. first car, home deposit etc), so…. They’re going to get sold anyway….. so what's the benefit? Answer? Probably not much.
Common & best answer “Invest in your name, for your grandchildren”
This is the simplest, most flexible, easiest and most tax-efficient manner. To simply invest the money in your name, perhaps with the account designation that of your grandchild. The money will be held in your name and the proceeds will be taxable income. That said, the first $18,200 is tax-free (more if you’re over 67), and franking credits should take care of any tax bill up to $45,000 per annum.
Now one consideration, is that these assets will be considered for social security (e.g. Age Pension and Commonwealth Seniors Health Card), so if that’s important to you, it’s worth considering.
So when the kids turn 18 and start to commence their studies, the assets will likely be cashed out, causing a CGT event. Now it’s a fair chance that your marginal tax rate will be lower than university age kids and secondly, the assets aren’t meant to be transferred to the kids, the proceeds are. So this ownership is likely going to provide the best tax outcomes for all circumstances.
What to buy
You said that “low cost” is front of mind for you. Well, opening accounts in your name for your grandchildren gives you the broadest possible range of investments. Let’s talk about that.
Ok, let’s address the top 3 people will think of: Shares (e.g. Banks, Woollies etc), Listed Investment Companies (LICs) and Exchange Traded Funds (ETFs).
From what you are describing ETFs are hands down the best option. In every way. They’re lower cost, better diversified, more flexible and don’t come with all of the added headaches of LICs. Listed Investment Companies, or LICs, are a common solution for this strategy, however, they first came about in the early ’90s, long before ETFs. In addition to having much lower returns and higher fees, they are too reliant on franking credits and are stubbornly difficult to trade. ETFs are simply a modern alternative, it’s like comparing an early 90’s car to a modern car.
A good low-cost option would be a diversified ETF. There’s so many to choose from, some of the more well-known are Vanguard or Blackrock products. These are extremely simple to set up, simply open a share trading account, purchase the ETF, make sure to reinvest the profits (dividends), there should be an “Automatic reinvestment” option. After this, you can simply set and forget for literally 18 years. You won’t need to pay any admin fees, the management fees are typically very low, as long as you stick to a very mainstream product, you really should be able to not check it at all.
By choosing an ETF over say, a few direct shares, you are taking up the only free lunch in investing, diversification. You might be able to buy 1 – 5 companies on the ASX which are all broadly similar, or you could buy an ETF that invests across the entire ASX200, or across the entire globe with small holdings in Australia, the US, Europe & Japan. This is the best option for a 12-year view. There are many choices available to Australian investors, the overwhelming majority of which give fantastic value, brilliant diversification, and solid returns.
If it were my money, I’d want to use something like the Vanguard Diversified High Growth Index ETF, giving me low costs, great diversification and a strong allocation to stocks. You should consider how much risk you’re willing to take, but on a minimum 12-year investment horizon, a strong allocation to equities is likely going to serve you well.
It might be worth completing a risk profile, our website (www.advisemetoday.com.au) has a free risk profiler that might assist you in determining what asset allocation might suit, as well as educational resources around asset allocation and risk.
Big bucks
There is one thing that would make me change my mind, and that is if we were dealing with a substantial investment sum, e.g. over $200,000. If this were the case, I would strongly recommend seeking professional advice to assess the benefits of a discretionary family trust. These come with significant setup costs and ongoing reporting requirements. There’s also the often overlooked but often superior strategy of investing the funds in a standalone super account, e.g. a low-cost industry fund, however, that comes with many considerations best discussed with an adviser.
This is something that we’ve talked about on our website before, so I encourage you to have a look at www.advisemetoday.com.au
I hope this helps,
Andy
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Comments2
"Hi James, I'm glad we had the same experience reading each other's writing. In short, you are incorrect. 1. I am familiar with and a fan of Affluence. It is simply ludicrous to use that fund as a "benchmark" for an entire sector, most particularly in this instance as it is a Fund, and such, not subject to perennially and "stubbornly" trading and at a discount to NTA. 2. LICs are in a decline and this is by virtue of the fact there are far better investment vehicles, to suggest a LIC being the premier structure for an investment timeframe of 18 years is ridiculous and irresponsible. 3. The costs of LICs are poorly understood, particularly the examples where costs of the manager are billed to the company, and then a management fee is charged on the NTA, representing at least double the fee any similar fund would charge. Again, many funds book all expenses to the listed vehicle, then charge their fee on the NTA, representing a repugnant "double-dip" good for managers, abhorrent for investors. have you ever wondered how so many minuscule <$50M Aussie Equities \ LICs can exist? This segues me to: 4. The notion of having a LIC & same vehicle accessible by a fund as well is farcical, there is no conceivable benefit from buying on-market unless you believe that it will reach NTA, and you are likely agreeing to a more salacious fee structure for the LIC (e.g. Magellan, L1). 5. You reference Affluence as a benchmark - which again is completely inappropriate - when it itself, is a Fund - I repeat a Fund - designed specifically to exploit a sector rife with structural failings and systemic dysfunction. I would challenge you to you name a single LIC that has outperformed the market on a 5 or 7-year basis? I suspect you cannot, and, even if you could, I would hazard a guess it would one of the myriad of substandard, sub $50M Mkt Cap examples that, by virtue of its structure, would have its performance massacred by any meaningful redemption due to the nature of being a listed company, as well as the thin trading volumes synonymous with the sector. Ergo, a significant drawback from such a strategy. AFIC, Argo, Milton are all examples of a time that is now gone, newer examples are simply cash-grabs for managers with permanent capital and lucrative fee structures, the only LIC with any rationale investment theme is VGI, which itself trades at a persistent discount to NTA, despite having one of the only virtuous fee structures and rationale behind listing (the LIC represents the only method of entry for 99% of Australians), thus, giving no hope to the sector. My heart weeps for Firetrail and PNI.asx that L1 had to go and ruin it for everyone, and I feel good for everyone that they did. Mr Financial Adviser: Investment bond providers are thoroughly uninspiring. Their own incompetence is beaten only by the institutions that provide them. The purveyors of such products (ala IOOF) are more likely to be out of business in 18 years than they are to be in business in 18 years. investment bonds are useful for one single instance and that is shielding wealth from a divorce"
Andy Darroch 00:10 on 03 Sep 21
"Insurance bonds are a bad idea? Investment bonds are high cost and poor performing? Not sure what insurance bonds this guy is talking about, but given that there are some cheap, low-cost insurance bonds out there, an you can choose the investments within them - I tend to disagree and think that insurance bonds could be an excellent choice for this case study. Hmm....."
Financial Adviser 15:33 on 01 Sep 21