3 best ways to invest for a child
After being gifted some money after the birth of my baby, I wanted to know the best ways to invest for a child. I wanted to ensure that my kid would be set up for financial success in the future, however, I wasn’t sure of the best ways to invest, till I did a bit more research.
As part of the FIRE (Financial Independence Retire Early) movement, it only makes sense that I would want to teach my kid the benefit of investing.
I know the powerful benefit of compound interest, and if I can take advantage of investing early, my kiddo will reap the benefits. I often lament not understanding the full benefit of compounding interest until I finally stumbled upon the FIRE movement … but that’s a story for another time.
Why would you want to invest for a child?
There are many reasons why you would want to invest for a child. Perhaps you want to have a forced savings plan for their future. Maybe, you want to be able to help them out with a downpayment. Or, you just want to give them a head start in life.
Whatever the reason, it’s always great to look at the various options to invest for a kid and see what suits you and your families needs best.
3 best ways to invest for a child
So, what are the three best ways to invest for a child? They are:
Invest via a trust
Invest via investment bonds
Invest directly as a parent
Let’s dive deeper into each of the investment options.
1. Invest via a trust
Everyone I talked to suggested setting up a family trust. It’s a popular option in Australia because the tax benefits can be substantial. However, there are some initial costs and annual accounting that might mitigate the benefits if the amount invested isn’t significant enough.
The benefits of investing via a trust are:
Flexibility to invest in various assets (a trust can hold shares, property, and other asset classes)
Asset protection (property ownership can belong to the trust instead of the individual, as it is classed as a separate legal entity)
Minimizing taxes (depending on how the trust is set up, you can distribute income to lower tax earners to reduce taxes)
The disadvantage of investing via a trust are:
The initial costs of setting it up (can be a few thousand dollars)
Annual costs of accounting to maintain the trust
Additional administrative work during tax time
The parent acts as the trustee and therefore would not be able to have absolute say on how the money should be used (depending on how the trust is set up)
The money is tied up in the trust and cannot be used for other purposes
Now, of course a trust can be set up to suit the individual’s needs, but for my situation, the lack of flexibility and the paperwork (and costs) seemed onerous. Plus I wanted the money to be a tad more liquid. So, I gave it a pass.
2. Invest via investment bonds
Don’t be fooled by the name, investment bonds aren’t just bonds. They are basically a tax effective investment vehicle that can be set up for a child and held for ten years without incurring any personal CGT (Capital Gains Tax) when withdrawn. It’s a great way to set and forget money you want to invest.
The benefits of investing via investment bonds are:
It’s quite tax efficient if you hold the money for 10+ years and are in a high-earning tax bracket
No personal CGT after 10 years (although it is taxed at 30% within the bond)
No additional accounting is necessary, since the fund pays the tax on behalf of the investor
You can withdraw the amount at anytime
Able to set conditions for the minor receiving the money
Easy set and forget vehicle for investing
The disadvantage of investing via investment bonds are:
There’s usually a cost associated with holding an insurance bond (via the company) that can eat into the earnings (admin fee / MER)
Lack of flexibility (need to put away the money for 10 years to reap the tax benefits)
Using an external company (similar to super management) to invest the money on your behalf
May only be beneficial if you are in a higher tax threshold
This is a great way to invest, especially if the strategy is to ‘set and forget’. However, unless you’re in a high earning tax bracket, the tax advantage is negligible. You’d have to crunch the numbers to see if it’s worth it. I decided to give this option a pass as well.
3. Invest directly as a parent
The third option is to just invest for your kid as you would for yourself. Although there are no foreseen tax benefits, the flexibility and ease of investing under your own name can be quite simple.
The benefits of investing directly as a parent:
Flexibility in assets, stocks and what you want to do with the money
Low fees if you purchase cheap index funds
Can be more advantageous if invested in lower income earning parent’s name
The disadvantage of investing directly as a parent:
No tax advantage
It’s not set up in the child’s name and any income occurred impacts the investor directly
Any CGT and earnings will add to your taxable income
This is probably the simplest way to invest although it’s not the most tax efficient, especially if you are a high income earner. However, it provides quite a bit of flexibility and allows for the parent to have total say and control over how the money is invested and what it can be used for.
Lodging a tax return for your child
It’s worth noting that you might have to lodge a tax return for your child if you choose to invest in their name. If the child is under 18 years old and owns shares that earn more than $416, you must lodge a tax return for them. The ATO website has more details as to what you should consider if you choose this path.
What did I decide to go with?
I’m sure you can guess, I decided that investing directly made the most sense for our situation.
The reasoning is, as an expat, I’m not sure where we will be living in the future. Whether that will be in Australia, Canada or somewhere in between. For me, flexibility and simplicity was my biggest priority. Therefore, I wanted to be able to have full control of our child’s investments.
Also, I didn’t want to have to pay a huge set-up fee and annual accounting fees for a trust, nor did I want to have money tied up in an investment bond which might not benefit us tax-wise. Therefore, investing directly in index funds made the most sense for us.
I decided to get a new Holder Identification Number (HIN) and invest directly via my broker. The reason for a new HIN was that I didn’t want to mix my personal investments with that of my kids, especially if I was planning on investing in the same ETF’s (Exchange Traded Funds). This makes it easier to invest, track, and down the line, sell.
All in all, I’m excited to watch my kids’ money grow, and see compound interest do it’s thing over the next few decades. Even with the ups and downs of the market it will be great to see the money grow into a larger sum that can be used for a downpayment of a house, education, or if my kid wants to, buy more shares.