I have 3 pre-teen children and would like to start an investment portfolio for them. How much do I need, and what would be the best way to do this?
Simon, in Richmond, Vic
Top answer provided by:
That is a really great question and one that I am getting more and more often from clients that want to teach their children about the power of compounding, the value in investing and to help the children get a leg up in life.
Tax on minors
It can be problematic investing directly in your children’s name due to tax on minors which relates to children under the age of 18 (as at 30 June of a year) and generally applied to unearned income (for example, dividends or other investment income). This results in minors generally being taxed at higher tax rates on unearned income such as interest, rent and dividends. This can see their investment income taxed at a rate of up to 66%! Generally, the tax on minors rules out having the investments directly held in the child’s name as this can often result in there being higher than necessary tax paid. There are exceptions for certain children working full-time, with disabilities or who are entitled to a double orphan pension.
Common ownership approach
The most common approach for creating an investment for your children is to purchase the investment “in trust” for the children, this is generally done in the parent or grandparent’s name as trustee. For tax purposes, the ATO determines who has control of the assets, and therefore who pays tax on the income earned. If the money for the investment is provided by you and you use the money as if it were your own, then you should declare the income on your tax return (however I would speak with a specialist tax accountant about this). Once each of your children turn 18 it may be possible to transfer the investment into their name as they would no longer be subject to minor tax, which will also free the trustee from having to declare the income and capital gains as their assessable income (capital gains tax may apply on such a transfer).
Different investment options
An insurance bond is a little like a managed fund. It may be withdrawn in part or full at any time, although there may be tax implications. It can be established in the child’s name for those aged 10 to 16 with parental consent. Anyone over 16 can invest without consent.
For children under 16, insurance bonds generally also offer a ‘child advancement option’, where a parent or grandparent invests on behalf of the child, with ownership passing at a nominated ‘vesting’ age. This could tie in with making funds available for home deposit or travel and so on.
The insurance bond pays income tax within the bond (up to 30%), so you don't need to include earnings in your personal tax return (or a return for the child). If the insurance bond is held for 10 years or more, then when it is withdrawn, there is no further tax to be paid i.e. if the investment has appreciated in value, no capital gains needs to be paid. Generally, if one of the parents aren’t paying substantially more than 30 per cent in income tax – these products may not provide the best financial return.
The minimum initial contribution to an investment bond is generally $1,000. After you make the initial contribution you are able to make subsequent contributions, to the initial investment, but additional investments are limited to 125 per cent of the previous year’s investment amount if you wish your children to be able to take advantage of the tax free status on any withdrawals after 10 years. An additional investment that exceeds 125 per cent of the previous year’s investment will re-start the ten-year term.
Exchange Traded Fund (ETF)
Exchange traded fund (ETF) is a type of security that involves a collection of securities—such as listed stocks that often tracks an underlying index, however some ETFs track specific assets such as a currency or commodity. Just like shares, you are able to purchase and trade ETF’s on the ASX, but unlike a stock, which focuses on one company, an ETF tracks an index, a commodity, bonds, or a basket of securities. Generally, ETFs can be one of the most cost-effective ways to invest a smaller amount of money whilst ensuring the funds are appropriately diversified across different sectors and asset classes.
- Instead of buying one single share you could buy an ETF that only invests in the ASX top 200 stocks, this would see the single investment diversified across 200 stocks whilst you would only hold one ETF and incur one brokerage fee.
- Generally, appropriate diversification is key to investing. If you wanted to ensure that the funds were invested across Australian shares, International shares, Property, Fixed interest and Bonds – you could invest in one ETF that aim’s to be invested across all of these sectors to provide greater diversification.
Generally for ETF’s you are able to buy your first ETF with an initial investment as little as $500 however it is important to note that you will be charged brokerage, the amount of brokerage will depend on the transaction size, for an initial investment figure of $500 the brokerage may equate to 2% of the initial investment. Because you pay each time you trade an ETF, if you are looking to put in place a regular savings plan whereby you invest a small amount more frequently, you may find that you could be better off in a managed fund than in an ETF, so that you don’t incur a brokerage fee every time you invest. However, many ETFs can be accessed at a lower price per annum than managed funds
A managed fund pools money from many investors to invest in securities such as shares, bonds or other assets. Managed funds are overseen by investment professionals. Profits, losses and costs are shared by all investors. Managed funds allow individuals to achieve diversification, usually at a lower cost, more efficiently than if they assembled their own portfolios of individual securities.
Managed funds and share investments generally require legal capacity, which doesn’t apply to under-18s. Therefore, these are usually registered in an adult’s name. The fund manager or share registry may allow for a name that reflects the intention, ie John Smith in trust for Jane Smith.
Managed funds typically require an investor to invest a minimum amount, which can be in the region of $2000 - $5000 for a retail fund. Managed funds may be a better option for those who don't want a brokerage account and prefer to make regular contributions to their investment fund through dollar-cost averaging or some other method.
In summary, for such a simple question, there are a lot of different factors that need to be considered before making a decision on how to invest, how much to invest and the ownership of the investment, being that you don’t want to pay unnecessary tax by choosing the wrong ownership and you want to ensure appropriate diversification.
ETFs may make more sense for people who are willing to set up, or already have, a brokerage account and want to be able to trade at a specific price and who don't make regular contributions. Managed funds may be a better option if you are looking to make regular contributions. Insurance Bond may be appropriate if you (and your parents or partner) are on a higher tax rate, although typically investment options are limited. Furthermore, what is appropriate for you and your children may not be appropriate for someone else. As always, ensure you speak with a financial planner before making a decision.
Authorised representative and credit representative
Of Paul Carter Pty Ltd, ABN 16 079 780 895, trading as Provident Financial Services is an authorised representative and credit representative of AMP Financial Planning Pty Limited, ABN 89 051 208 327 (“AMPFP”), Australian Financial Services Licensee and Australian Credit Licensee.
This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.
While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.