A question we get from time to time is about parents wanting to set up a bank account or a share investment portfolio for their children.
We love this idea as it’s a great way for the kids to get ahead. Whether the money goes to education in time, or helping them with their first house – it’s a great head start!
The two things we need to consider about putting money away for the kids’ is:
Who pays the tax on any earnings, and also
How we structure the holding of those assets
We know that what structure that those investments are held in will determine, firstly, who owns the asset when considering asset protection, but also who pays the tax on the earnings from the investments.
In Australia, children under 18 aren’t actually seen as legal entities, and so they cannot hold bank accounts or share portfolios directly in their names.
What the banks or the share portfolio providers will want to do is set up the parents or parent as trustee for the child, so it’s very similar to a discretionary trust we talk about, where you’ve got this trust account with a trustee or the guardian of the trust making decisions for it.
In the case of children, if you go to a bank and set up a bank account, if it was my child, it would be Ben Walker As Trustee for Monkey. (That’s the name of one of our dogs, no human children yet!)
What will happen is say I put $10,000 into the account, and over the course of year it earns $500 in interest. The unfortunate thing about it is that interest will actually be taxable in my personal name.
Sometimes we don’t want that, especially if the parent is a high income earner, and they’re already paying a high amount of tax, and also the other spouse may also be on a high tax bracket. Any interest earned in the name of the child’s trust account is actually taxable to the parents, and usually is not desirable.
The alternative to that is to actually set up a discretionary trust or a family trust for your children.
We’d have a clean trust for holding assets beneficially for you and your children. You would still need ‘you’ as an individual or a company you own to be a trustee of their trust. But the difference is set up correctly, it wouldn’t all be taxed in your name.
Let’s use the same scenario that $10,000 in cash was put into the discretionary trust account and it earned $500 of interest. The first $416 per child of income that that trust earns can actually be distributed to them tax free.
Why $416? That’s the number that the ATO has set that minors (under 18 year olds) can earn from investments without paying the top rate of tax.
In previous years, that distributable amount has been thousands of dollars per child, so that dropped down the limit that a child can receive tax free significantly.
If you had more than $416 in income per child, then that would have to go to another family member. It could be paid to you, but it all depends on your family situation – retired parents or lower income family (who are over 18 years old) are best. It could also be paid to what we call a “bucket company”. There’s actually another article where I’ve written all about bucket companies and how useful they can be.
The best ‘tax time’ for this type of investment is when your child turns 18. They then get taxed like an adult – so the first $20,000 or so they earn is tax free!! This can be very helpful so they pay little or no tax on the investments you’ve put away for them, while they might be studying or travelling after school.
That’s a bit of an overview on setting up a savings account or a share portfolio for your children.
Again, if you’re looking to build up quite a significant balance over the years, then getting the structure right from the start will mean you don’t need to change it down the track, which could cost you a fair bit of money in capital gains tax.
Also in the meantime, if it just stays in your name as trustee for your child, then you might be paying 34.5 cents in the dollar, or 39 cents in the dollar, or even worse, 47 cents in the dollar in tax, which is usually not great.