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Investing for your kids or grandchildren – part 1

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 Hatchimals HatchiBabies or the LOL Big Surprise, when they are 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 investment.

In this, the first of two feature articles, I’m looking at taxation issues, road test the bank accounts that are designed for kids and how to buy shares for minors. Next week, I’ll focus on some of the special investment products  – insurance bonds and education funds.

Let’s talk tax

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 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.

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 franking credits are included as unearned income. Your child or grandchild will also get the benefit of the franking credits, which are applied for a second time to act as a tax offset. 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 $10,658 before paying any tax. Under this size, they will be eligible for a refund in cash of all or part of the franking 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.

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 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.

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

Who’s 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 (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 Jack by depositing $5,000. Wayne is a signatory to the account because Jack is 4 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 8 and has a savings account in her name. Shauna’s mother is a signatory to the account. The funds (totalling $90) are birthday and Christmas presents from Shauna’s relatives. Interest earned from the account is considered to be Shauna’s.”

Which bank account to open?

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 2.40% pa provided one deposit is made per month (usually no size requirements) and no withdrawals are made. All the accounts are fee free for minors.

            Rates and conditions as at 7 December 2018 and subject to change.

Of the majors, NAB offers the best rate – a standard interest rate of 0.5% and a bonus interest rate of 1.90%, meaning a total rate potential of 2.40%. The bonus rate is paid if there is at least one deposit in the month and no withdrawals.

Westpac has introduced a new account for the under 18s, Bump Savings. It pays the highest standard rate of 1.5% (materially higher than ANZ’s 0.01%) but its total rate potential is marginally less at 2.30% and it may require that a linked transaction account be opened.

Account opening requirements vary. If the child is over 12, most banks allow the child to open it (14 years for the CBA) and it will be held in the child’s name. Under 12 will require a parent to open the account, and while some banks title the account in the child’s name, others use a trust structure. Parental controls are available. 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 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? 

Buying shares for minors

I am a big fan of buying shares for minors because I think the experience can be particularly educational and help foster a life-long interest in investing.

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, the 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 a lot greater affinity with that company. And as a customer, they get to sample and evaluate first-hand the services of the company they part own.

Opening a share account for a minor

Opening a share account for a minor is getting harder because the brokers have been 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 to operate.

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 direct registration to minors.

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

<Mary Jane Smith A/C>                    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 vs transaction costs (brokerage), and finding 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 $10.00 or $29.95 – this represents transaction costs of 2.0% 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 where there are going to be so many up 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 $5,000, I would select:

$1,000 of my child’s bank (e.g. Commonwealth Bank)

$1,000 of the company where we buy our groceries (e.g. Woolworths)

$1,000 of a mining or resources company (probably BHP or Woodside)

$1,000 of a telco or major online business that they may experience (Telstra or Seek)

$1,000 of a major health care company (probably CSL, Ramsay or Cochlear)

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 (in most cases) 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 ($181.50 by telephone).

CommSec offers 4 categories of share packs: Capital Growth, Income, Market Leaders and Tax Effective Income. Each pack comprises 6 equally weighted companies, selected by the CommSec Research team. On Friday, a $5,000 Market Leaders share pack comprised the following stocks:

CommSec Market Leaders Share Pack

The Capital Growth pack was as follows:

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 or Transurban 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 (by your child or grandchild) 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 (one day) appreciate any gift of shares – no matter how large or small. Just don’t expect rapturous applause on Christmas morning!

Coming up next week – insurance bonds and education funds. Stay tuned!

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 regard to your circumstances.