Investing for kids

Most people I speak to would like to give their kids a head-start, especially if they have not had that themselves. This may be in the form of saving for their education, helping with kid’s future property, a car and so on. If you ever googled the phrase, "Investing for kids", you will find that there are many ways of doing it and it really comes down to your circumstances, objectives, and aspirations. I describe some options with a focus on saving for education, but these vehicles can be used for other purposes. Before deciding, please do your own research as this is not a comprehensive list. If you would like advice on which option would be appropriate for your family, please reach out to me, or another registered Financial Adviser.

1.???Listed Australian Shares

Investment in Australian shares, which pay fully franked dividends, is one option. Imputation credits currently provide a rebate of 30 cents in the dollar which means you pay less tax on your dividend income. Shares are one of the highest performing investment sectors over the longer term; that is, five or more years, which is the typical time frame most people are considering for education funding.

It is important to note that children under the age of 18 are by law not able to enter into a contract. Therefore, in most circumstances the account is opened in the adult's name (i.e. one or both parents, or grandparents) as trustee for the child or children. This is generally known as an "informal trust". From a tax perspective, it is important you seek professional tax advice to determine which type of ownership will provide the most tax-effective outcome for you and your child. This is because the trustee, or parent/guardian, could be liable for income and capital gains tax liabilities as a result of presumed ownership.

The other drawback with investing in direct holdings is that you can't establish a regular "top up" scheme, or savings plan; unless you invest via a company’s Dividend Reinvestment Plan, if available. Considering most initial amounts gifted to children are fairly modest it is hard to achieve cost-effective diversification without at least $50,000 to invest. So placing small amounts in a choice of one or two or three companies leaves you exposed to a higher risk if one or more of these investments fails or underperforms.

2. Managed Funds / Listed Investment Companies (LICs) / ETFs

To overcome the issue of diversification, many advisers suggest using a managed vehicle for children's’ investments. An unlisted managed fund or a listed investment company (LIC) are popular choices. The advantage for both of these types of investments is that a manager makes all investment decisions for the investor and handles all administration matters (including detailed taxation statements).

Managed funds are a useful investment tool because you can establish an effective regular savings scheme; starting with a modest sum, typically $1,000, and investing as little as $100 on a regular monthly basis. This approach also takes advantage of the dollar-cost averaging principle to reduce the market timing risk associated with investing in growth investments such as shares.

From a tax perspective actively managed share funds do tend to deliver realised capital gains on a regular basis although this is probably less critical under the current capital gains tax regime. For investments held for more than 12 months only 50% of any realised capital gain is added to your taxable income and taxed at your marginal tax rate.

LICs often show more transparent value than a managed fund. An investor can see this value in the listed share price whereas a managed fund has a more complicated buy and sell “spread” value and a longer redemption period when withdrawing funds. LIC annual management fees can also be lower than annual managed fund fees. Unfortunately, as with listed shares, LICs do not offer regular savings schemes.

Exchange-traded funds, or ETFs, are becoming more popular and like LICs, provide the investor with an opportunity to access various markets with a smaller amount of money. ETFs are investment vehicles that provide exposure to a basket of shares, listed property, commodities, fixed income or currencies and in most cases, track a certain index, such as the S&P/ASX 200, which represents 200 of the largest companies in Australia. They have a slight advantage over LICs in that they can be bought and sold for close to the value of their underlying assets (i.e. index). This usually results in the ETF price very closely matching the performance of the index. ?

If the ETF’s underlying assets produce income investors will receive regular income distributions. ETFs pass on this income untaxed and franking credits are also passed through. Management fees are quite low compared to managed funds, ranging from as little as 0.07% to 1% for some actively managed ETFs.

Investment Bonds - Insurance Bonds & Friendly Society Bonds

Investment Bonds can be a useful vehicle when saving for education purposes. With many investments such as shares and unit trusts, responsibility for the payment of tax is passed on to the investor. This means any profits or losses you make must be included in your annual tax return for the year in which you earn them. With investment bonds, earnings are retained within the investment funds and tax is paid by the provider at a flat tax rate of 30%. Investors do not need to declare any income on their tax return until a withdrawal is made. If the investment is held for 10 years or more, there is no additional tax to pay. If funds are withdrawn before 10 years, the investor will receive a rebate which can be used to offset additional tax payable.

For this reason, investment bonds are a popular choice for education savings. Specific education savings funds are available, modelled via the investment bond structure, although provider choice is limited. Education savings bonds are particularly designed for education expenses; however, some providers allow flexibility to use the bond for non-education expenses. They are often cheaper than other alternatives, particularly where investments are restricted to cash or fixed interest. They can also be quite inflexible if your need for these funds change, so any decision to use them should be carefully considered.

Tax is paid by the bond provider at the rate of 30%, thus this is likely to suit those parents with higher income tax bracket. It is also worth noting that the actual tax rate can be lower due to franking credits if the fund invests in listed equities. Tax benefits can be enhanced further for education related expenses as the tax is claimed back by the provider from the ATO and is included in withdrawal proceeds to the student.

Self-Funding Instalment Warrants

Instalment warrants provide the opportunity to purchase listed shares by way of two payments, known as the First Payment and the Instalment Payment. Instalment warrants allow the holder to benefit from the growth and income of the shares without having to pay for the security in full, hence the yield from the investment is enhanced.

Self-funding instalment warrants are similar to the traditional instalment warrants in that there are two main payments: one at the start and an optional payment at the end of the investment term. However, they differ from traditional instalment warrants in that any dividends paid on the shares during the investment term are not received directly in cash by the holder but are used to reduce the loan amount and therefore the instalment payment.

These types of warrants may be a viable option for education savings plans as they provide potential tax advantages and long-term savings benefits.

1. Firstly, holders may be able to claim income tax deductions on a part of the interest amount incurred for the time the self-funding instalment is held.

2. Secondly, many of the shares over which self-funding instalments are issued yield fully franked dividends.

3. Thirdly, an investment in self-funding instalment warrants allows the holder to "set and forget" the investment for the investment term, as dividends are applied to reduce the instalment payment (loan amount) and with no annual cash payments required from the holder during the investment term. In addition, yearly interest payments are paid on the holder's behalf and added to the instalment payment automatically.

Whichever investment option you choose should best match your investment objectives and risk profile. Tax may also play an important role when deciding which investment strategy to use. In that regard, it is important you seek qualified tax advice before implementing your strategy.

Shaun Rasulov, Senior Wealth Adviser?

Level 2 Tower B The Zenith, 821 Pacific Highway Chatswood, NSW 2067

Email: [email protected]

Direct: 02 8116 1741 | Mobile: 0466 783 044

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