Why investing in your child’s name can be a bad idea

Investing for your children while they’re young can be a great way to help set them up for future financial success. But before you start pouring money into their account, there are a few tax issues you should know about.

Investing in your child’s name can attract high tax rates
While you might be considering setting up an investment account in your child’s name, this can be problematic. That’s because minors can only earn up to $416 on investment income each year before tax rates as high as 66% are applied. This is to deter parents from trying to lower their tax bill by sheltering assets in their child’s name.

The table below shows the tax rates on ‘unearned income’ received by minors.

Income (p.a.) Tax on unearned income received by minors
$0 – $416 Nil
$417 – $1,307            66% on amounts above $416
Above $1,307 45% on all income that is not excepted income


Why investing in your own name can be preferable
As a parent, it might be simpler to invest directly in your own name and withdraw the money later when you’re ready to give it to your child. This way, the earnings are taxed at the adult marginal tax rates rather than the penalty rates that apply to minors.

Of course, when the time comes to transfer ownership of the asset to your child, you may trigger a capital gains tax (CGT) event. This can result in a hefty tax bill, especially if you’ve been investing over several decades. Fortunately, there are options available to help lower your tax liability.

For example, if you’ve held a CGT-related investment for more than 12 months before selling, you’ll only have to pay tax on 50% of the net capital gain. And you might be able to reduce your tax burden further by selling in a year when income is low.

Investment bonds
Investment bonds, sometimes known as insurance bonds, are an investment product that is offered by insurance companies and friendly societies. Your money is pooled with other investors’ money and invested in an asset — or bundle of assets — of your choice.

Earnings on the underlying investment are taxed in the bond up to a maximum of 30% before being reinvested. This can make investment bonds quite tax effective for high income-earners, provided that certain conditions are met.

For withdrawals to be excluded from your tax return (i.e. considered ‘tax paid’) you need to hold the bond for at least ten years and adhere to the 125% rule — that is, make sure any additional investments you make do not exceed 125% of the investments you made in the previous year. 

While the bond could be purchased in the parent’s name, policies exist which allow ownership to be automatically transferred to your child once they reach the nominated vesting age (usually between the ages of 10 and 25).

Family discretionary trusts
For parents who intend to invest a large sum of money (usually upwards of $100,000), one option is to set up a family discretionary trust. This is a legal agreement in which parents can hold investments on trust for the benefit of their family and other beneficiaries (e.g. their children, other trusts, companies and/or charities).

As the trustee, you are free to distribute the income to as many beneficiaries as you like, so long as they qualify as a beneficiary as per the trust deed. Once the income is distributed to the beneficiaries, they will then pay tax at their personal tax rate. The higher tax rate for a minor’s unearned income still applies, however the trustee has discretion to pay excess income to other beneficiaries.

Informal trusts
This option is similar to investing in your own name but there is an additional step involved. When opening up a share trading account, you might be able to ask your broker to list you as the trustee and your child as the beneficial owner.

Provided it is genuinely your child’s investment, it won’t trigger a CGT event when it’s eventually transferred to your child. The downside is any income and capital gains will still be taxed at the child tax rates. 

Superannuation
If you’re fine waiting until retirement before giving your children their money, investing through your super can be a worthwhile — and tax effective — option. That’s because you may be able to claim contributions you make from your take-home pay as a tax deduction.

This will involve filling out what’s known as a Notice of Intent form and sending it to your super fund. If submitted in time, you’ll pay less income tax and your contribution will be taxed at the concessional rate (usually 15%) and earnings are then taxed at no more than 15%.

Alternatively, you can choose to invest in your child’s super account. Of course, since super is intended to be a long-term savings vehicle, your child will only be able to access it when a condition of release is met.

Also note that if your child is over 18, the contribution will be treated as a concessional contribution and taxed at 15%. It may be better for the child to make their own super contributions, so they could potentially qualify for FHSSS, a co-contribution and/or a personal tax deduction. 

Holding it in your offset account
If you have a mortgage, you might also consider holding the money you intend to give to your children in your offset account. The goal here is to reduce your interest costs so you’re left with more money to hand to your child once your mortgage has been paid off.

Under current gifting rules, neither you nor your child will have to pay tax when the money is eventually transferred to their account. But limits will apply if you receive an income support benefit such as the Age Pension within the next five years. 

According to Centrelink, you can only give away $10,000 in a year (or up to $30,000 over five years) without the money being included in the assets and income tests for the next five years.

Regardless of which investment option you’re leaning towards, consider meeting with a qualified financial advisor first to discuss the potential pros and cons, along with what you can expect when it comes to tax.

 
Article from: shartruwealth.financialknowledgecentre.com.au