I want to invest for 5 grandchildren, who are all under 7 currently. I want a 'low' cost option that will give consistent returns over the long run. I anticipate funds could be available for their education, maybe to buy a car or to help them in some other milestone event, perhaps even travel.
From GS in Melbourne
Top answer provided by:
Pj Patterson
I love this question posed by a grandparent about investing for their five grandchildren who are all under the age of seven. Investing for children is something that I advocate. Sadly, I feel too many people only consider investing for their children (or grandchildren) once they are much older. I believe it is important to get a good start financially and having a grandparent willing to make an investment for their grandchildren is really special.
There are many advantages to doing this, which I'll go into shortly, but before I do that, I just want to say that I truly believe as an advisor that learning about investing begins at home. Unfortunately our schools don't teach investing and how to invest. The only knowledge we seem to get is from our parents or our grandparents and of course our friends. Even university courses lack the depth and detail required to really learn about finances and investing. While we trust those people and institutions, unless they are a professional such as a Financial Planner they might not have the full tool set to provide proper advice.
Back to our generous grandparents; I believe the best product in Australia for them to help the grandkids is to use an investment bond. An investment bond is a product issued by a life insurance company with the underlying investment typically a basket of managed funds. You are able to pick a strategy such as Growth or Balanced and the real kicker is that after 10 years of ownership the income and capital gains are tax free!
However, there are some very important rules around investment bonds, one of which is the 125% rule, meaning you can only put in a maximum of 125% of the previous year's contribution. So, in simple terms, if the grandparents started that investment account with $1,000, the maximum they could put in the next year would be $1,125.What the grandparents would do is set up an investment bond for each grandchild and then contribute to that investment bond on a regular basis, say monthly or lump sum one-off contributions. The parents and even the children (once they are working) could make contributions as well, just be mindful of that 125% rule.
Investment Bonds have some incredible advantages:
- They are tax paid while invested so there is no personal assessable income.
- As mentioned, withdrawals after the ten year tax period are free of personal income tax.
- Nominated beneficiaries can be paid quickly and directly upon the life insureds death.
- Because they are tax paid they can be held for children under 18 without any tax consequence.
One of the company's I use for investment bonds has a unique product feature that allows you borrow against the bond. This would allow the grandparents to become the bank of Nan and Pop. It also means that they don't have to draw down on the capital to pay for things like education or a holiday and could effectively provide a very low interest loan to the grandchild. Something to think about!
There are some other interesting ways to use Investment Bonds but for me this product is absolutely, without doubt, the best way in Australia to invest for grandchildren or children for that matter. As always be sure to seek professional advice on these matters before doing anything.
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Comments9
"Agree that without more information you cannot really pin down an appropriate solution here. But if you are considering Bonds and education is one of the primary objectives (first one mentioned) then an Education Bond which refunds the tax paid would seem a better option than a standard Investment Bond and you don't have the 125% rule to consider."
Andrew 16:49 on 22 Feb 19
"It would depend on how much you plan on saving for each Grandchild. If it is around $10,000 - the interest rate on a savings account in the childs name earning less than 4.16% will be perfectly fine and wouldn't affect your own finances (including Centrelink etc). It is a simple solution. And would be a good starting point for now. Then if the interest earnings reach $416 per annum you could look at other options. I think this is certainly a gap in the market. When they are a little older (in their teenage years) you could provide them with the funds to invest in the share market - a way of educating them as well as them watching the funds grow (or fluctuate) and appreciate what you are contributing to their future. They will also learn about capital and income and range of other valuable lessons."
Triona 16:26 on 22 Feb 19
"Death?, point 3 refers to the ability with some Insurance Bonds to actually nominate a beneficiary(ies) for the distribution of the Bond value, thus bypassing the Estate. Bank accounts (with higher interest) or even managed funds could be suitable. Separate consideration needs to be given to ownership [grandparent(s), or parent(s)], with any of them being the life (lives) insured. Any of them could be suitable investments. I agree with all of the previous comments, Insurance Bonds are not necessarily the best option given the limited amount of information about the grandparent and the circumstances. "
Lindsay 16:12 on 22 Feb 19
"I think this is a very hard question to answer. One commenter (Fergus) highlighted the clients desire for consistent returns over the long run and so mentioned a bank account. It would be crucial to gain the clients understanding of what they mean by consistent return and their understanding of risk return relationship and volatility would be very important also. Maybe the client expects that he can have those consistent returns but still have higher average returns than a bank account could offer. Is a bank account appropriate for investing money that you expect to access in, say, 10 years? Also, to answer these questions much more needs to be understood about the situation of the client and the children's parents. An investment bond provides that 30% tax rate that was mentioned which can be great where the parents and grandparents have higher marginal tax rates than this. But what if the grandparents have the vast majority of their financial investments in superannuation pensions and can invest in their own name tax free (as Fergus also mentioned in his reference to the "lower taxed entity"). What does the client mean by low cost? I dont know of any low cost investment bonds when the investment and administration fees are taken into acocunt. Bank accounts can be free but maybe they can just purchase a Vanguard Multisector index fund, choosing one that matches the risk return profile that the client is comfortable with. That might cost roughly 0.3% per annum of the amount invested, and is easily managed and redeemed when the funds are required. If the grandparents pay no tax, the investment earnings will likely be tax free. Again, this is not an easy question to answer and there are too many unknown variables. But understanding the investment bond mentioned and how they work is a good start, but then you need to apply that to the clients situation to see if it is the best option for them."
Tom 16:07 on 22 Feb 19
"How'd I know that as soon as I saw the question, insurance/investment bonds were going to be dragged out as the answer. 30% tax on income and capital gains (with no CGT discount) internally within the fund plus the additional fee an insurance bond attracts means after tax, net returns are going to be sub par no matter which way you look at it. The grandparents are probably retired, or near enough to, so they have the ability to invest in a low/no tax environment (i.e their own name) and just give the grandchildren money. But, as always, the higher cost, higher tax and more complicated solution is put forward with the 'tax effective' lipstick on."
Glenn 15:48 on 22 Feb 19
"The answer is not 100% correct and the maths is a little off. 125% of $1000 isn't $1125!"
TC 15:36 on 22 Feb 19
"In regard to GS from Melbourne's enquiry...they asked for: ".... consistent returns over the long run" while an INSURANCE BOND maybe just the ticket for them (unless able to invest in a lower taxed entity), they will not necessarily achieve a consistent return over the long term, especially if they are investing in today's expensive investment environment (Balanced options took 5 years to recover post GFC). Maybe in the short term a CUA YOUTH SAVER paying 4% on balances up to $5,000 would be a solution (tax free in each grandchild's name if interest income less than $416pa each) then look at other options such as Investment Bonds and look at taking on greater risk after asset markets correct and become cheaper and thus less RISKY. Alternatively, if GS from Melbourne is in a low tax situation, continue to invest in your own name and contribute to education expenses as they fall due. "
Fergus Hardingham 15:32 on 22 Feb 19
"Why is the second years contribution limited to $1125. Thought you could have put in $1250"
Peter 15:23 on 22 Feb 19
"I'm sorry, I don't understand point 3 in the benefits of investment bonds section. What's it got to do with someone dying? Are investment bonds only produced by life insurers and you can only invest in them if you have life insurance??"
Death? 14:39 on 22 Feb 19