Australia is a great place to live, but living well doesn’t come cheap – and it’s not getting any easier. Investing for your kids can give them a head start in life on their pathway to financial security and independence.
The opportunity here is huge – if you invest just $6 daily based on the long term Australian sharemarket return of 9.8%, by the time your child reaches 18 they’ll have a cool $107,133 – but it’s what happens next that’s even more valuable.
If your child doesn’t invest a single dollar more, and leaves that money to grow, by the time they reach age 65 they’d have over $8.5m in investments. Keep in mind that with inflation a latte will probably be costing them $50 by then, but either way this is a serious amount of cash and will go a long way to financial security.
But figuring out the best way to invest for your kids can be complicated and confusing, and it’s easy to end up overwhelmed and have this end up in the too hard basket. In this piece we unpack the key things you need to know to invest for your kids the smart way.
What sort of investments are best when you’re investing for children
When you invest there are two broad categories of investments you want to consider.
Firstly you have ‘defensive’ investments like cash, where the expected return is low relative to other investments like shares, but where you get stable returns over time with low risk of losing money.
The second group is ‘growth’ investments like shares and property, that over time are expected to deliver returns above what you get from cash, but at the same time are subject to the ups and downs of the sharemarket and economy.
There is no ‘right way’ here, but you should know that the biggest indicator you should be looking at to make the right call is how long you’re aiming to invest your money for.
If you’re only investing for a week or a month, generally speaking defensive investments are better because they’re less likely to go down in the shorter term. For example, if you know you need money next week to spend on something, investing into the sharemarket can be quite risky because what will happen in the next few days is uncertain.
On the flip side, if you’re investing for the long term, you generally have the time to wait out a market recovery if there is a downturn. This is why when you’re young and have a long time until retirement, generally accepted wisdom with investing your superannuation is to chock it full of shares and growth investments, and minimise your cash and defensive holdings.
If you’re investing for your kids and have a 10 year plus timeframe, this suggests you probably want to have more quality shares and less defensive investments, to deliver a better return for you and ultimately for your children.
Don’t fall into the common trap of thinking that if you’re investing more into growth investments that you need to take on speculative risk like the risk of investing into small companies. These investments generally have even more ups and downs than the broader market, and in my view if you’re looking for quality, stable investments for the long term can be avoided entirely.
How to invest for your kids
If you want to invest for your kids, one of the first things on your list should be to open an investment account. You can do this by either opening a dedicated account for your child, or even multiple accounts for multiple children, or some people choose to nominate a specific investment within an existing investment account for their kids.
Again there are lots of ways to be right here, and ultimately I’m pretty sure whatever you do, your child will appreciate it.
But having a separate account for kids investing in my view is a solid way to go about things, because it has the advantage of giving you clarity on what investments are ‘yours’ and which are nominated for your kids. Having separate accounts also allows you to structure things in different ways from a tax perspective which can have some further advantages (unpacked below).
If you’re running multiple investment accounts, you can choose to have the same legal and tax ownership for multiple accounts, or structure these differently (explained further below).
Investing for your children and tax
Before you actually get started investing for your children, you want to make sure you understand the tax implications. The exact implications for your family will depend on how your investments are actually structured.
From a legal and tax perspective, there are two main ways you can go about investing for your kids.
- You hold investments in your name, with the intention of gifting these investments to your child in the future.
- You hold investments in your name, but with your child nominated as the beneficiary
Owning investments for your children | Investing with your child in mind
If you hold investments in your name, all assessable (taxable) income and capital gains will be added to your taxable income and need to be included in your tax return. You then pay tax on investment income and gains each year.
If you proceed this way, in the future you can transfer the ownership of the investments to your child through an ‘off market transfer’ where any investments don’t actually need to be sold – but this is considered a transfer of legal ownership and therefore a taxable event.
Structuring investments in this way also gives you more flexibility and control, as you can decide when, how much, and how to transfer any investments at any time in the future. But the downside of this is that you need to pay the tax each year into the future, and at the time of transfer.
Pro tip: Many parents that go down this path will sell down investments at the time of gifting assets to their child, then use part of the proceeds to pay the tax, then gift the net amount to their children.
Owning investments in your child’s name | Investing on behalf of your child
Under this pathway, you’re investing on behalf of your children with them as the beneficiaries, and parents as the trustee.
When you buy shares, you’re asked to provide a tax file number (TFN). Children can apply for a TFN with no minimum age, and aren’t exempt from providing a TFN. If you don’t provide a TFN when you open an investment account, tax will be withheld at a rate of 47% from unfranked dividend income earned on the shares. Further, if your child owns shares and earns more than $416 each year, you’re required to lodge a tax return on their behalf. If they earn less than $416, you can choose to (and may want to) lodge a tax return to claim any refunds or franking credits.
Special rules and tax rates apply to income earned by people under 18, with some income being taxed at higher rates than adults. ‘Non-excepted’ income is taxed at a rate of 0% on the first $416 earned each year, then 66% for income between $417 and $1,307, and 45% for any income earned above $1,307 p.a.
If your account is held with your child as the beneficial owner, you can either quote their TFN, and in this case any income received in dividends or capital gains will be considered ‘non-excepted income’ and subject to these tax rates. Any income your children receive in dividends or capital gains on the sale of shares will be non-excepted income, subject to these tax rates.
The alternative is that you quote your TFN, and then you will pay tax at your marginal rate on all income and gains. In the future when your child turns 18 (or starts earning their own money if earlier), you can change the account to their TFN.
If you structure your investments in this way, one big advantage is that when you ultimately fully transfer the investments to them, when there is no change in beneficial ownership, there are no tax implications for the parents on the transfer according to the ATO. This means no capital gains tax would be due or payable at the time of transfer, which can save some serious tax dollars.
Choosing between beneficial ownership and holding in your name
The implication here is that if you’re already earning income that puts you into the top marginal tax bracket, the tax on investing in your name with your child in mind compared to investing in your child’s name is that the tax will be pretty much the same. But, if you’re not in the top marginal tax bracket already, the tax will be lower by owning investments in your name.
As mentioned above, this option also provides you with more flexibility around when and how you ultimately transfer the investments to your child. That being said, owning investments in your child’s name will likely mean less capital gains tax in the future when you transfer investments to your child.
Both options have their advantages and downsides, and ultimately the right decision depends on you. It can be helpful to get some personal advice on this, which would allow you to clearly map out the financial outcomes from both pathways and make the best choice for you and your family.
Either way though, you don’t want to let trying to do it perfectly stop you from getting it done. You’ll likely find that the biggest benefit you get from investing from your kids comes when you get started asap, and keep in mind that you can always change your approach as your investments grow.
For most people, we suggest getting started investing to get your momentum building, then when your investments grow to around $50k you can look to get some quality advice that can help you take things to the next level, and ensure everything is optimised before your investments build to the point that it gets expensive to restructure things.
Deciding when to gift
Whilst a minor can’t hold investments in their name, there is no requirement to gift/transfer the investments to the child immediately when they turn 18 or any time really. Once they’re old enough, it’s really up to you to decide when you think they’re ready.
Who can gift?
The topics discussed above could apply to any legitimate minor-adult relationship. There are no specific exclusions that would prohibit say a grandparent or Aunty or Uncle or even non-biological family-figures. Of course, it’s likely the ATO would take a very negative view of someone attempting to take advantage of the $416 tax-free threshold for their own gain. So, like with all things tax related, the risks of doing something wrong far outway any potential saving.
We’re lucky to live in one of the most amazing countries on the planet, but living well in Australia doesn’t come cheap – and it’s not getting any easier.
Investing for your kids can help them build their early money momentum, and help make their bigger money moves like getting into the property market easier. It can be slightly complicated and confusing if you don’t understand the rules and how to use them to your advantage, but it’s worth working for.
Get this right and you can almost guarantee an enjoyable mothers day and fathers day (at the very least) into the future.
If you want to learn more about how to invest smarter and save more, check out the Pivot Smart Money Accelerator
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek personal advice from a finance professional.