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It is
great when friends and relatives invest on behalf
of children. It not only has the potential to provide for the
child's future needs including education, buying their first car or
saving for a house deposit, but it also
has the potential benefit of teaching the child
important money management and investing skills.
Before discussing the investment
side of things, it is worth mentioning the potential for knowledge, money management principles
and wisdom that can be passed onto children if they are actively involved
in the process. Learning these skills will provide ongoing benefit that will continue
into the child's adult life and may well exceed the
actual investment value.
While the child recipient is still pretty
young it is best to direct the annual gift directly to the
investment however in the future, when the child is older,
it may be worth giving him or her the money and mentoring him
in spending a portion, saving a portion and giving a portion. The
actual percentages are less important than the principle it teaches,
however, the idea in this case is to focus on saving
(investing) the majority.
Our eldest
child, Caleb, was given $25 by his
Uncle in April this year and we encouraged him to put $12.50 in the
bank, give $2.50 and spend $10. I’m not sure how much he really
understood about the saving and giving bit but he learnt a valuable
lesson about spending. We went to a toy shop and he found
a porcelain piggy bank he loved. It was $9 and therefore within his $10 budget.
And although we encouraged him to buy something more interesting he
was determined to buy the piggy bank. Later that evening having played
with the porcelain piggy bank all day, he was standing
on tip toes reaching to get it off the mantel piece, where we placed
it so his younger brothers wouldn’t break it, and it slipped through
his finger tips and shattered into thousands of pieces on the
floor. We could have gone out the next day and replaced it
but we decided to use it as a learning tool. After consoling him and wiping
away the tears, we encouraged him to think of some jobs he could do
to earn some money and buy another piggy bank.
Apart
from the principles you can teach a child, by far the next
most important aspect of investing for the future of children is to
save regularly and start early. The earlier you start the longer you
can utilise compounding (earning interest on interest) in your
favour.
As for the
investing side of things there are two decisions to be made:
1. Whose
name is the investment going to be
in?
2. What should the
underlying investment be?
Whose
name is the investment going to be in?
There are four
broad options:
1. In the
name of the child – a child under 18 generally cannot make an
investment in his or her own name. The investment would be made by a
parent/guardian who will hold that investment on trust for the
child. For example the investment would be purchased in the name of
"Grandma Generous as trustee for Blessed Johny".
2. In the name
of the spouse who is on the lower marginal tax rate (in the case
of parents are investing for the children
3. In a family
trust, or
4. In an
insurance bond.
If an
investment is made in the name of the child the investment income is
usually taxed at penalty tax rates.
For the 2007-08
year, Australian minors who are not an excepted person and have no
excepted income, they will be taxed as follows:
Minor
Income Tax rate
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$0-416 |
0% |
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$417 - $1,307 |
66% of excess over $416 |
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$1,308 and above |
45% of the entire amount
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N ote that the low income tax offset of $750
effectively increases the tax free threshold for minors non-excepted income from $416 to
$1,667.
As long as the
investment earnings did not exceed $1,667 it would be appropriate to
invest in the child’s name.
In the case the funds
are invested in a savings account, if the interest income is $120
or more, then you need to quote the child’s tax file number, or Pay
As You Go tax will be withheld.
What
should the underlying investment be?
There
are several investment vehicles for savings and the preferred
option will vary depending on the circumstances.
The range of
options include:
•
Term deposits and hi-yield internet savings
accounts
•
Insurance bonds
•
Scholarship
funds
• Managed
funds
• Direct
shares
• Pay off your non-deductible debt (home
mortgage)
•
Pre-pay school fees
• Family
trust
With minimal
initial investment there are limited options available beyond a high
yielding bank account. $3,000 - $5,000 makes it possible to invest
in a managed fund such as a Vanguard Index fund that is available to
retail investors. It has a minimum required balance of $3,000.
Regular investments of $100 can be made via BPay.
Otherwise a Listed Investment Company such as Australian
Foundation Investment Company (AFIC) may be appropriate, however, the brokerage costs of $30-60 per transaction
for additional investments are a drawback.
Depending on the
amount to be invested, you could contribute regularly (Christmas and
birthdays for example) into a high yielding bank account for the
recipient child and then as the balance becomes sufficient to invest then move
it into either a listed investment company like AFIC (which will assist
teaching about shares) or Vanguard (which can also provide a good investing
lesson).
The other
possibility is to float the idea of getting a lump sum together with
other relatives who would like to be part of the child's investment
plan to assist in jump starting the process with a larger initial
investment.
As
the child becomes old enough to work another way to both pass on
good saving habits and increase savings
is to match the amount of money the child
saves from their employment. My father encouraged me to buy my first shareholding at age
15 and the lessons I learned at this age were invaluable. Happy
investing!
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This
newsletter does not take into account the personal objectives,
financial situation or needs of any person. You should consider the
appropriateness of the information having regard to your own
objectives, financial situation and needs and obtain professional
financial advice prior to making any decision.
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