Question 1: Our eldest third son is about to enter high school in 2022. We both work full time and are looking at starting a new nest egg for the boys, approximately $5000-$10,000 each per annum while in high school. Should we look at a trust or buying the shares in their name?

In years to come I’m sure your boys will be very grateful for the nest eggs.

Many people invest directly in the child’s name (where possible), while others invest on behalf of the child using managed funds or other options where the investment is held in the adult’s name ‘as trustee for’ the child.

This usually results in the creation of an informal trust arrangement.

It is important to consider the following before investing for a child:

• The purpose and timeframe for the investment
• The level of risk/target return
• Taxation
• Access to funds
• How much control of the money is required?

Tax

Tax is something that needs to be considered upfront.

A number of factors will determine whether the income is taxed in the hands of the minor, the adult investing on the child’s behalf, or the trustee of a trust of which the minor is a beneficiary.

If the income is assessed as being derived by the child, the rate of tax payable by a minor depends on a number of factors, including:

• The source of the income
• Personal circumstances of the minor, employment status and whether the person has a specified disability.

Generally, income earned by a minor is taxed at special minor rates which are higher than adult rates (so adults don’t just place money in the child’s name to reduce their tax bill).

Source: ATO

‘Unearned’ income derived by minors is generally taxed at the higher minor rate, except in special circumstances. Unearned income is is generally passively derived income such as:

• Bank interest
• Share dividends
• Distributions from managed funds
• Distributions from discretionary trusts.

This means the maximum amount of unearned income a child can receive tax free is $416 per annum.

Note that employment income, deceased estate income, social security income and net capital gains from investments are taxed at normal adult rates.

Buying shares direct

Children usually cannot buy shares in their own name, so to avoid the need for a formal trust the most common (and easiest) approach is to create an account in the name of an adult (e.g. parent) with the shares held in trust for the child.

By law, the adult is the legal owner of the shares, but the minor is the beneficiary. If held ‘as trustee for’ the child, an informal trust arrangement would normally arise, and child tax rates may apply.

If simply held in your name (the adult’s name), the dividends will be taxed at the adult’s marginal rate.

Australian shares provide the potential for long-term growth and give you control over the investments and may spark an interest in investing for your children.

However, disadvantages include limited diversification as the money invested would only go towards a small number of shares (companies).

Managed funds

Managed funds are a good alternative to directly held investments, such as cash-based accounts or shares.

However, similar to shares, a child cannot invest in a managed fund in his or her own name.

An adult must open the account, either in their own name outright, where earnings will be taxable at their marginal rate, or ‘as trustee for’ the child, where an informal trust arrangement would normally arise and child tax rates may apply.

Key advantages of managed funds include:

• High long-term growth potential
• Professional investment management
• Diversification as the fund would hold many investments
• Low minimum investments required.

However, managed funds charge management fees and offer you no control over the investment decisions.

Investment or education bonds

These are invested in the same way as a managed fund.

With an investment bond (also called an insurance bond), the earnings are taxed at 30 per cent regardless of what your marginal tax rate is, so they can be tax effective for higher-income earners.

The bond could then pass on to the child at a certain age, say 21 or 25 (whatever you like), and if it has been held for at least 10 years, no further tax applies.

Education bonds are similar and are even more tax effective if the funds are used to pay education expenses. But if that is not the purpose of the bond, then a regular investment bond may be better.

So, in summary, there are two key considerations:

• Do you invest directly (i.e. chose some shares yourself) or indirectly via managed funds or exchange traded funds (ETFs)?
• And do you hold the funds in your name only, or as trustee for your children, or via an investment bond?

Getting these decisions right is important, so I would suggest seeking tax advice from a licensed accountant before getting started.

Question 2: Hi Craig, my husband (age 58) and I (age 56) plan to retire in four years when I turn 60. We have a SMSF worth $1.2 million which generates an income of $60,000-$70,000 a year. We have a property investment portfolio worth about $8 million, with $3 million in mortgages.

We plan to sell our home (worth $3 million) to repay the mortgage upon retirement and move into one of the investment properties to live.

We understand that the income from the investment properties will be taxed accordingly. However, we would like to know if we will pay tax on the income generated by the SMSF once we retire (even though we will retire earlier than the “official “retirement age)? Regards, Andrea

Hi, Andrea,

Congratulations on building up your investment portfolio.

With such a large property portfolio outside of super, hopefully your SMSF invests in other types of assets to provide you with diversification.

Australia does not have an ‘official’ retirement age.

There is an age at which you become eligible for the age pension, and an age at which you can access superannuation. However, if you have the financial resources to do so, you can retire at any age you like.

All superannuation payments, income or lump sum withdrawals, are received tax free once you turn 60.

This is regardless of whether it is from a SMSF, or an APRA-regulated fund (industry or retail). So, as you will both be 60 or over when you retire, the super payments will be tax free.

However, I need to make a distinction between superannuation income payments made from the SMSF to you (or your husband) and income received by the SMSF due to its investments (i.e. any interest or dividends achieved by the SMSF and re-invested).

You have stated that your SMSF generates an income of $60,000-$70,000 a year, presumably this currently stays within the SMSF and is reinvested.

If the SMSF stays within the ‘accumulation’ stage, then this income will be taxed internally at a rate of 15 per cent (less any offsets).

But if you move the SMSF into pension phase, or if you roll over your SMSF into an industry super pension or a retail pension fund, then all internal earnings will be tax free.

If you have an accountant or adviser who helps you look after your SMSF they will be able to provide you with more information around this.

Craig Sankey is a licensed financial adviser and head of Technical Services & Advice Enablement at Industry Fund Services

Disclaimer: The responses provided are general in nature, and while they are prompted by the questions asked, they have been prepared without taking into consideration all your objectives, financial situation or needs.

Before relying on any of the information, please ensure that you consider the appropriateness of the information for your objectives, financial situation or needs. To the extent that it is permitted by law, no responsibility for errors or omissions is accepted by IFS and its representatives. 

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