Children – How to give them a financial leg up
Parenting kids comes with an extensive list of challenges, from the everyday mundane, to the unseen in the future. A lot of the challenge when they start to get older is financial. The cost of raising children can skyrocket, so it’s important to plan ahead, and do as much as you to plan for the future.
If you are a parent you are fully aware that the cost of private education is continually rising, with some schools charging fees of up to $20,000 a year, sometimes more; and that doesn’t include uniforms, excursions and after school activities. The cost of earning a degree particularly in the popular disciplines like law, IT and medicine is also rising.
The bottom line is that education is getting more expensive and competition for entry to the best courses will only get stiffer. Rather than having your children start their working life with a debt hanging over their heads, starting a savings plan when they are young is the answer. The key is to put a sound plan in place as early as possible and stick to it.
Most parents know the importance of doing this but are unsure how to start or what product or strategy to follow, particularly when there are tricky tax rules to be aware of. For example, if you put the investments in your own name any interest income is added to your taxable income and may reduce your Family Tax Benefits. If you put the investments in your child’s name, penalty tax rates apply once they have “unearned” income in excess of $416. So what do you do?
Here are a number of options to consider:
One option is an “investment bond”. These products sometimes have other names but are essentially taxpaid life policies where you choose the investment strategy. If they are held for at least ten years the proceeds are tax-free when cashed in.
A useful feature is that the investor can make a contribution of up to 125% of the previous year’s contribution and retain the tax-free status after ten years. Income is reinvested and not included in the investor’s taxable income. If you cash it in before ten years there may be tax payable but you can use the proceeds for any purpose – not just for education expenses.
Friendly society education plans
These are similar to investment bonds in some ways. The friendly society pays tax at 30% and income is reinvested. However, a special tax concession allows the friendly society to claim back the tax paid if the funds are used for educational purposes.
The plan proceeds must be used for educational purposes but there is more flexibility in making contributions and withdrawing funds than with an investment bond.
Gearing into Australian shares
Personally borrowing to invest can be a tax-effective strategy because you can claim deductions for the interest cost and use imputation credits to reduce the tax payable. Just be aware that when you cash the investment in to pay school fees you may have to pay capital gains tax.
Mortgage offset account
If you have a mortgage you can build up funds in a mortgage offset account. This works both ways by reducing your interest costs at the same time. You can draw on the offset account when school fees become due.
One solution rarely suits every person and we recommend that you talk to your adviser to determine which of the above options best suits you and your family’s circumstances.
Another thing to consider is helping your children plan for their future financially, through helping them make investments. It’s a fun and easy way to teach your children about money, investing, and future planning. Every parent wants the best for their child, so if you are in a position to invest money specifically for your children’s future, you should follow the same approach as if you were investing personally.
Start with clearly identifying why you are investing, set a goal and put the strategy into place. A range of options is available depending on your attitude to investing and the investment time frame. For short-term goals, a high interest earning savings fund may be appropriate and for medium to long-term goals, managed funds and direct shares could be suitable. For longer term goals, a geared instalment program may be appropriate.
One taxing question is in whose name to hold the investment. Children are taxed at penalty rates on unearned income. They can receive income of up to $416 in 2015/16. For example, an investment of $5,942 earning 7% pa this financial year would be tax-free if held in the child’s name.
Other options to avoid the high rates of tax include:
Investment bonds where income is reinvested and the life office pays tax at 30%. The proceeds of the bond are tax-free after 10 years and the child can be named as the beneficiary. Investing in the name of the parent on the lowest marginal tax rate. A parent who has no other income could earn around $140,000 in fully franked dividends and pay no tax. A parent already earning $30,000 could earn around $45,000 in fully franked dividends and pay no extra tax.
Investing using an ‘implied trust’ where the investment is held in the parents’ name in trust for the child. The child enjoys the tax-free threshold of $6,000 and the parents keep control. Beware that the investment must be used for the benefit of the child or the Tax Office can attribute the income to the parents and tax them personally.
There are plenty of options, so talk to your financial adviser about an appropriate solution for your situation and that of your children.
Another way to help your children is to help them gain a bit of a financial headstart in life. There are so many options available, however, your generosity could create tax issues down the track. Here we explore this topic from a few different angles, depending on how you wish to help them.
If you want to guarantee that money invested for a specific purpose in your child’s life is used for that intention, there are a number of ways to make sure this happens.
If you look around, there are plenty of investment products aimed squarely at helping parents save for education. Education funds are often referred to as “Education Savings Plans”. The savings plans can be set up to transfer to the child’s name at an age specified by you. Many of these funds charge minimal fees and the funds can be used for paying for books and uniforms, repaying HECS debts, and even to purchase musical instruments and lessons.
Due to the increasing difficulty faced by many young Australians in saving for their first home, assistance from family members is likely to become more common. A facility is available which enables parents to help with the purchase at no direct cost to themselves. The “family guarantee” loan allows parents, or another family member, to use their own home as security on a portion of their child’s mortgage, generally to increase their deposit amount.
If you choose to act as a guarantor, be aware of the implications. For example, you may be responsible for the entire loan if your offspring cannot meet repayments; or even worse, if they default on the loan and the lender sells the property at a loss, you may be at risk of losing your own home. Another option that places less risk on your assets is to lend your child money to make or increase their home deposit. Combining a parent’s loan with the first homeowner grant can make a substantial impact on the life of the mortgage.
Accessing tax breaks
Parents may be well aware of the value that spreading income across family members can have when it comes to tax time. But beware. The Australian Tax Office ensures money is not placed in children’s names purely to give Mum and Dad a tax break. For this reason, it can apply more aggressive tax rates for passive income invested in the name of a person under age 18. So when setting up any investment in this way, make sure you check with your adviser first.
The key to giving your kids a leg-up is to have a clear objective before you start. With so many options available it can get confusing so be sure to ask us for professional financial advice.
Disclaimer: The information provided on this website has been provided as general advice only. We have not considered your financial circumstances, needs or objectives and you should seek the assistance of your Synchron Adviser before you make any decision regarding any products mentioned in this communication. Whilst all care has been taken in the preparation of this material, no warranty is given in respect of the information provided and accordingly neither Mirador Wealth Management, Synchron, nor its related entities, employees or agents shall be liable on any ground whatsoever with respect to decisions or actions taken as a result of you acting upon such information. Authorised Representatives of Synchron AFS Licence No. 243313