Investing for your kids or grandchildren - Switzer Report

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Investing for your kids or grandchildren

Ever thought about investing for your kids or grandchildren? It might be simpler than you think. Co-founder of the Switzer Super Report and founding CEO and managing director of CommSec, Paul Rickard, has put together a three-part series so that you can learn to invest well for your loved ones. They'll thank you later!

Sincerely,

Peter Switzer

Inside this Issue

Investing for your kids or grandchildren ? Part 1 by Paul Rickard

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02 Investing for your kids or grandchildren ? Part 1 by Paul Rickard Christmas present

05 Investing for your kids or grandchildren ? Part 2 by Paul Rickard Thank you later

08 Investing for your kids or grandchildren - Part 3 by Paul Rickard Tax benefits

Switzer Super Report is published by Switzer Financial Group Pty Ltd AFSL No. 286 531 36-40 Queen Street, Woollahra, 2025 T: 1300 SWITZER (1300 794 8937) F: (02) 9327 4366

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual's objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Investing for your kids or grandchildren ? Part 1

by Paul Rickard

Key points

Minors are subject to special rules when it comes to taxation to discourage adults from splitting their income with their children. Unearned income will be taxed at special rates. With the income on fully franked shares, both the dividend in cash and the imputation credits are included as unearned income. There are special bank accounts for kids that can offer up to 3.73% interest under certain conditions.

income and diverting it to their children. "Unearned" income for a minor, which includes income such as interest on a bank account, dividends from shares, or a trust distribution is taxed at the following special rates:

"Unearned income" doesn't qualify for the normal tax-free threshold of $18,200.

With Christmas fast approaching, the idea of investing for your kids or grandchildren may be something you have been considering. While it is unlikely to produce the same "under-the tree" reaction as unwrapping the latest Smartwatch or Elsa Doll, when they're a young adult, they should have something material to show for your gift. If the gift is shares or an insurance bond, they may also develop an ongoing interest in investing.

In this the first of three feature articles, we will look at taxation issues, including how interest or dividend income earned by a minor is taxed, and applying for a TFN. Then we will road test the bank accounts that are designed for kids. In the second article, we will look at buying shares for minors, and the final article will focus on some of the special investment products ? insurance bonds and education funds.

Taxation

So for example, if your grandson's bank account earns $1,000 in interest, then tax of $385 will be payable (0.0 x $416) + (0.66 x $584) = $385.

When it comes to income on fully franked shares, both the dividend in cash and the imputation credits are included as unearned income. Your child or grandchild will also get the benefit of the imputation credits, which are further applied to act as a tax rebate. Putting these together, if we assume an average fully franked dividend yield of 5%, this means that your child/grandchild can have a share portfolio of $10,677 before paying any tax. Under this size, they will be eligible for a refund in cash of all or part of the imputation credits.

Does your child need a TFN?

There is no obligation to provide a Tax File Number (TFN) or exemption to a bank or company. If you don't, then PAYG tax on interest or unfranked dividends may be deducted.

Minors (persons under the age of 18) are subject to special rules when it comes to taxation. The rules are designed to discourage adults from splitting their

If you are opening the bank account (or share account) in your name in trust for your child or grandchild, then you should quote your TFN (unless

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there is a formal trust in which case quote the TFN of the trust). Just because you quote your TFN doesn't make you liable to pay any tax.

from the account is considered to be Shauna's." Bank accounts

If you are opening the account in your child's name, most banks will generally accept you nominating the "child under 16" exemption (this doesn't mean that they won't pay any tax ? it just means that PAYG tax won't be deducted). If they are 16 or 17 and earn more than $120 in investment income, they should apply for and quote their own TFN.

In fact, a child at any age can apply for and get a TFN ? there is no minimum age. A birth certificate or passport, and one other document, such as a school report is all that is required. The ATO also runs a program with secondary schools that makes getting a TFN easy.

Banks will typically recommend that you open a "bonus interest rate" style account for kids. These accounts are structured to reward regular deposits.

As the following table shows, your child can earn interest at a rate of 3.73% pa provided one deposit is made per month (usually no size requirements), and no withdrawals are made.

Who is liable for the tax on the income?

Notwithstanding whose TFN is quoted, the ATO says that who declares the interest depends on who owns or uses the funds of the account.

The parent (or grandparent) owns the money if they provided the money and they spend it as they like, whether or not they spend it on providing resources for the child. If the parent owns the money, the parent includes the interest in their tax return.

In the case of a bank account, the ATO provides the following examples:

"Wayne opens an account for his son by depositing $5,000. Wayne is a signatory to the account because Jack is two years old. Wayne makes regular deposits and withdrawals to pay for Jack's pre-school expenses. Interest earned from the account is considered to be Wayne's."

On the other hand, if the funds in the account are not "excessive" and are not used by any person other than the child, then the interest earned will be the child's interest.

"Shauna is aged eight and has a savings account in her name. Shauna's mother is a signatory to the account. The funds are birthday and Christmas presents from Shauna's relatives. Interest earned

Rates and conditions as at 20 November 2014, and subject to change.

Of the majors, NAB currently offers the best rate ? a standard interest rate of 1.0%, and a bonus rate of 2.73%, meaning a total rate potential of 3.73%. The Commonwealth's Youthsaver is the easiest account to open. If you have a login to NetBank and your child has a birth certificate, you can potentially open the account totally online ? you don't need to visit a branch.

Some banks differentiate between under 12's and over 12's, allowing the latter to open the account in the child's name. Most provide an option for the child to be issued with a proprietary debit card like a `Keycard'.

As usual, it may pay to shop around to find the account that suits you and your child/grandchild best.

One final tip that came from a very helpful bank staff member. He volunteered that for his 13 year old daughter, he had opened two identical bonus saver

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accounts ? linked together online. The first is used to accumulate the savings and he makes sure a deposit is made each month to get the bonus interest rate. The second is used a bit like a transaction account where small balances are held ? and any debits are made. Who said that you can't get great advice from a banker? Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Investing for your kids or grandchildren ? Part 2

by Paul Rickard

Key points

Opening a share account for minors is getting harder which means, you have to open the account with a broker in your name, and effectively designate your child/grandchild as the beneficiary by placing their name in the account designation field.

When your child turns 18, you should be able to complete an `off-market' transfer that changes the ownership legally to your adult child.

Chose stocks that your child identifies with and are blue chips ? where they shop (Woolworths or Coles/Wesfarmers), where they bank (ANZ/CBA/NAB/Westpac), and their telecommunications provider (Telstra) are good places to start.

In the lead up to Christmas, this is the second of 3 feature articles on how to invest for your kids or grandchildren. The other week, we covered how minors (people aged under 18) are taxed, whether your child needs a TFN (tax file number) or not, who is liable for paying any tax and we also reviewed some of the bank deposit accounts especially designed for kids. (For our first article, please click here.)

Next week, we will focus on some of the special investment products ? insurance bonds and education funds. Today, we will look at how to buy shares for minors.

Buying shares

I am a big fan of buying shares for minors ? not because they might be the best performing investment (although they often are), but rather because I think the experience can be particularly educational and help foster a life-long interest in investing.

All the evidence points to the sharemarket being a fantastic creator of long term, tax effective wealth, so I am often dismayed when adults explain why they haven't invested in shares. The biggest reasons I hear is a misplaced fear that investing in shares is like punting or gambling (which is fanned by an ignorant media), or I simply don't know how to do it. Interestingly, you never seem to hear these "excuses" about property.

So, witnessing first hand the power of share marketing investing at a young age is a great way to overcome these barriers. Without banging this soapbox too loudly, I could almost develop an argument that every parent (subject to financial resources) has an obligation to get their kids to start investing in shares!

Name recognition, that is choosing companies that your kids might associate with because they buy or use the companies' products or services, is a big part of the story. The child's bank, supermarket where you shop, mobile phone provider etc can be good companies to start with in a portfolio, so that when the child gets the company's annual report and other correspondence, there will be some affinity with that company. And as a customer, they get to sample and evaluate first hand the offerings of the company they part own.

Opening a share account for a minor

Opening a share account for a minor is getting harder, mainly because the brokers have been

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required to tighten their customer identification procedures. Further, many brokers have automated account opening and identification systems, which just don't allow an under 18 year old to operate an account.

While there is no law that specifically says that shares cannot be owned by minors, some companies have a clause in their constitution that prohibits the registration of shares to minors. So, the ASX through CHESS, has adopted this convention and prohibits registration.

This means that in the absence of a formal trust, you have to open the account with a broker in your name, and effectively designate your child/grandchild as the beneficiary by placing their name in the account designation field.

The account will be set up, and shares registered, as follows: Frederick John Smith Parent/grandparent Child/grandchild

In law, you will be the legal owner, while the beneficial owner will be your child/grandchild. When your child turns 18, you should be able to complete an `off-market' transfer that changes the ownership legally to your adult child. As there will be no change of beneficial ownership, there shouldn't be any capital gains tax to pay.

Which shares to buy?

The starting point is to balance the size of the gift versus transaction costs (brokerage), then find some shares that are going to be good long-term performers. And hopefully, picking some companies that your child or grandchild will be able to identify with.

The minimum order size that you can place on the ASX for an initial investment is $500. However, if you are paying brokerage of $19.95 or $29.95 ? this represents transaction costs of 4.0% or 6.0% respectively ? a pretty big chunk. So, I would suggest that you try to get the parcel size up to at least $1,000.

You also want to select stocks that come from a diverse set of industries/sectors, and names that should be around in many years' time. It is hard enough thinking about the market in the short term ? so thinking about the long term when there are going to be so many ups and downs probably leads to the conclusion that you stick to the major blue chip companies.

If I was feeling particularly generous this Christmas and planning to gift $4,000, I would select:

$1,000 of my child's bank (Commonwealth Bank) $1,000 of the company where we buy our groceries (Woolworths) $1,000 of a mining or resources company (probably BHP or Woodside) $1,000 of our telco/mobile phoned provider (Telstra)

I make no claim that there is much "investment science" in the selection of this portfolio. However, there is some elementary diversification, they are companies my child should be able to identify with, I am confident that these companies are likely to be around in 10 years' time and I have an expectation that they should be able to pay fully-franked dividends.

CommSec's Share Packs

Rather than do the hard work yourself, an alternative is to purchase a Share Pack from CommSec (some of you may remember these as the old `Aussie Shares'). CommSec share packs are available in amounts from $4,000 (minimum) to $25,000 maximum. A very competitive fixed brokerage rate of $66 per share pack is charged for an online order.

CommSec offers four categories of share packs: Capital Growth, Income, Market Leaders and Tax Effective Income. Each pack comprises six equally weighted companies, selected by the CommSec Research team. On Friday, a $5,000 Market Leaders share pack comprised the following stocks:

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CommSec Market Leaders Share Pack

The Capital Growth pack was: CommSec Capital Growth Share Pack

These pre-mixed alternatives are easy to buy, cost effective and arguably, have a stronger element of diversification. While I can't readily see how Stockland qualifies under the "capital growth" label, let's assume that there is some science in their construction. The downside with these packs is that the name recognition may not be as high. Whether you use these pre-made packs from CommSec or do the hard work yourself and select one or more shares, in the long term, I am sure that your child or grandchild will appreciate any gift of shares ? no matter how large or small. Just don't expect rapturous applause on Christmas morning! Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Investing for your kids or grandchildren - part 3

by Paul Rickard

Key points

Insurance bonds (also called investment bonds) are long-term investment vehicles that offer tax efficiency for some investors.

Insurance bonds usually include a "child advancement policy"

Education savings plans are designed for saving for tertiary education and can be a tax-free way to save.

In the lead up to Christmas, we have been looking at how you can invest on behalf of your kids or grandchildren. In the first part of this 3 part series, we covered how minors (people aged under 18) are taxed, whether your child needs a TFN (tax file number) or not, who is liable for paying any tax and we also reviewed some of the bank deposit accounts especially designed for kids. (Click here for our first article).

Last week, we discussed how to buy shares directly for your kids ? either in a portfolio you create, or in a pre-mixed share pack. (View here).

In the third and final part of this series, we look at two indirect investment options ? insurance bonds and education savings plans.

What is an insurance/investment bond?

Insurance bonds (also called investment bonds) are long-term investment vehicles that offer tax efficiency for some investors. While technically incorporating a life insurance element, they are tax paid investments that focus on wealth creation by investing in single

asset (eg. `Australian shares') or multiple asset classes (eg. `balanced').

Insurance bonds are designed to be held for at least 10 years. The issuer of the bond pays tax on the earnings of the underlying investments at the corporate tax rate of 30%, which under a special tax rule, means that the investor does not need to include any investment earnings in his or her tax return. After 10 years, the investor can redeem the insurance bond and won't be liable for any capital gains tax.

If the investor chooses to redeem the insurance bond before 10 years, he or she is required to pay tax on the earnings of the bond at their marginal tax rate, less a tax offset of 30% to reflect the tax the issuer has already paid. If the bond is redeemed during the ninth or tenth year, transitional provisions apply.

One additional rule (known as the `125%' rule) makes them attractive as savings vehicles. Under this rule, investors can make additional contributions up to 25% of the previous year's contribution with the benefit of these contributions being treated as if they were invested at the same time as the original investment. For example, if you invested $1,000 to start an insurance bond, you could invest a further $1,250 in year two and a further $1,562.50 in year three and have, for tax purposes, the same 10-year term expiry being the tenth anniversary of the original $1,000.

How do they work for kids or grandchildren?

If the child is 10 years or over, then with parental consent, the investment can be made directly in the child's name. The minimum investment for some insurance bonds is as little as $500.

Most insurance bonds also include a `child advancement policy'. Under this feature, the

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