There’s more to helping out your kids financially than fattening their piggy bank. How you go about it will determine how much both they and the taxman ultimately receive. As the old saying goes, only two things are certain in life: death and taxes. And children aren’t exempt from this. There are a variety of factors to consider from the outset to ensure that your kids don’t wind up paying more in taxes than they ultimately receive from any money you put aside for them.
- Consider your why
Before determining where to put funds for your kids, first think about exactly why you want to do so. Is it to help with their education costs? To buy their first car? Save for a house deposit? Or give them a helping hand just because you love them? What the money is intended for will determine at what age they access it, which has tax implications, as well as the length of time these funds will need to grow. A house deposit will clearly take longer to save than a car purchase (unless perhaps you’re intending them to drive away in a Ferrari). This will also help determine whether those funds will be accessed as a lump sum or as an ongoing distribution/income stream once your child reaches a certain age. - Where will the funds come from?
Are you paying a lump sum to compound over time? Or do you plan to contribute small amounts regularly over the years to come? Perhaps your child has/will contribute money from their own savings and/or their pocket money or earnings from work? For babies, have you/will you ask family and friends to forgo presents of toys and clothes in favour of a financial contribution to their first savings account? Where the money comes from, and how often it will be topped up, will help guide you towards the right type of account or investment. - Structure it well
Once you have considered your child’s needs and your wishes in terms of purpose, flexibility, tax, and age, you’re able to better determine the right structure to use for their savings and investments. Whose name it is to be held in – yours and/or your partner’s, a company or Trust, or your child’s – as this will affect tax liabilities. One popular example is a Testamentary Trust, which comes into effect upon your death. However, it must be set up properly as part of your will. There are other trusts too that serve particular purposes, such as special disability trusts if you have a child with special needs, which have different concessions for Centrelink and tax. As part of your deliberations, consider risk, term, and whether you will have a capital gain or if it is just bank interest. Are you investing in a high-interest savings account, term deposit, bond, managed fund, property for example. - Factor childhood tax rates
Did you know that children are taxed differently to adults? Minors can earn just $416 of unearned income (that is, income generated from investments or dividends) tax-free per year before they pay a whopping 66 per cent tax. And the highest marginal tax rate is applied if that income exceeds $1,307. That is a stark contrast to the current $18,200 income tax-free threshold for adults. Knowing this difference may cause you to rethink your approach to letting children access investment income or distribute funds from a trust before they turn 18. - Are you a blended family?
Blended families account for 3.5 per cent of Australian families, while 8.5 per cent have a step-parent. A further 15.9 per cent of Aussie families are single parent households, meaning they too could become blended families in the future as new relationships form. Providing for children within these blended families warrants particular consideration. There is a need to ensure that children from both current and previous relationships are provided for equally. In doing so, the current partner/spouse should be protected while minimising what can be accessed or challenged by the ex. Given superannuation is treated separately from a will, naming children of previous relationships as beneficiaries can be a straightforward way of achieving this. - Don’t forget about inflation
With inflation currently at multi-decade highs, it is a timely reminder to analyse how inflation will affect the value of funds your child ultimately receives. For instance, low-yielding savings and investments may actually leave your kids with less buying power in real terms than what that money could buy today. Allowing children access to trust dividends or savings accounts at age 18, rather than say 25, could allow them to pre-pay tertiary education courses – avoiding hefty indexation on student loans and hence lowering their payable taxes during their working life.
Every parent wants the best for their children. If you are putting money aside for their future, the aim should be for them to get the best value from it.
Helen Baker is a licensed Australian financial adviser and author of On Your Own Two Feet: The Essential Guide to Financial Independence for all Women
www.onyourowntwofeet.com.au