Beware of hidden tax traps when investing for the grandkids
Our adviser outlines the smartest ways grandparents can set up investment accounts for their grandchildren to avoid hefty bills, while a pensioner’s property plan raises red flags.
We are keen to structure some investment accounts for our three grandchildren by providing an initial lump sum and then adding to their accounts periodically over the years until they reach 18. The account would be held in our name, in trust, until the grandchild reaches that age. We don’t intend to withdraw any money and want all dividends and interest reinvested back into those accounts. We want to understand the capital gains tax implications.
Mike, Avalon Beach, NSW
How lovely that you are looking to help your grandchildren, and are in a position to do so.
Having a capital gain is a good problem to have in the sense that it means you have made money. Capital gains are only on paper until they are “realised”, that is, sold or transacted.
If you hold an investment for longer than 12 months, then you will get a 50 per cent discount on the gain. The remaining funds are taxable at the marginal tax rate.
If you are reinvesting, and choose to sell down, then depending on the timing of sale and the timing of the dividends, you may not meet the 12-months criteria on that portion. If you are selling when markets are down, you may also make a capital loss. Losses cannot be offset against income.
Could your money be invested in a structure that reduces the impact of tax to stretch the money further? It is not clear how old the grandchildren are, or what your financial positions, or your ages, whether you are retired or still working, and if so, what your marginal tax rate is.
If funds are invested in trust for, then the gains and income are taxed at your marginal tax rate. If they are invested in a bond (not a fixed-interest bond, but a bond structure), if held for more than 10 years and all criteria is met, these are generally tax-free at that point.
Or, if you are retired and you are able to hold funds in a pension where all earnings and growth are tax free, and you have flexibility, does it make sense to invest there?
What you are invested in will also impact the returns. For example, if you are investing in what we call defensive investments, such as term deposits or high interest savers, they have no capital gain, just interest. Whereas, gold has capital gain but no income, and bonds/fixed interest have both capital gain and income.
If you are investing in growth investments, such as Australian shares, international shares, property, emerging markets or alternatives, they attract both capital gain and income, with Australian shares also delivering franking credits.
It is about managing strategy around the duration of investing, the ages of the grandchildren, and your financial situation to ensure you consider the tax rates, as well as the risk you want to take with the investments, and then your management of those investments. What is appropriate?
The other question, which is usually my first question, is what is the purpose of the money? Is it for a vehicle, secondary or tertiary education, or house deposit? If it is for a house deposit, depending on their age and if the first home buyers legislation remains in place, then it may make sense to invest there.
How should I structure buying a half-share in my partner’s home?
My partner and his stepdaughter each own a half share in the unit in which we live. They are tenants in common. I want to buy her half share. The purchase will involve a transfer, negating paying commission to a real estate agent. It will almost exhaust my savings and we are both aged pensioners with no other source of income. Is there a way the purchase can be facilitated to guarantee security for both sides of the deal?
Judy, Darwin
Without knowing your or your partner’s financial position, the value of the home, or your ages, your goals, spending plan, or how you manage money as a couple, it is prudent to highlight the issues we all face.
The first is the need for more funds than we needed previously due to the significant increase in cost of living. Several years ago, according to ASFA, a comfortable retirement for a couple was about $55,000 a year. This has now risen to about $73,000. That is an almost $20,000 a year increase.
Secondly, we are living for so much longer, meaning we need even more funds to see us through this longevity. Bearing in mind, health can change the outcome and aged care can be a factor to consider also.
So, my first question is, does your partner’s daughter need the money?
It sounds like using all of your funds to purchase a share in the home removes your liquidity, and is likely to impact your standard of living over the longer term.
Another consideration is what is in your partner’s will and your partner’s daughter’s will? As tenants in common each party owns their share and is able to distribute their half share in the property accordingly. This can be challenging in a situation like this if your partner dies; does your partner leave you their share? And vice-versa?
I’m not sure what the value of the home is and whether that means that you could afford to own a different home in your own name should anything change, or together if that was an option.
Another consideration could be to have a “life interest” in the property. This may allow you to keep your liquid funds and remain in the home, but this will also depend on the partner’s daughter’s plans, their financial position and what is in their wills.
You will also need to consider Centrelink as a homeowner or non-homeowner on the age pension.
Helen Baker is a licensed Australian financial adviser and author of Money For Life: How to build financial security from firm foundations. Follow her at @onyourowntwofeet.
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 relevant circumstances. Before relying on any of the information, please ensure that you consider the appropriateness of the information provided with regard to your objectives, financial situation and needs, and seek independent professional advice.
Welcome to our Dollars & Sense column. While in no way is it formal financial advice, it is a way to stress test your decision-making, to find out potential financial implications before you make your choice, and to discover more about structuring your affairs so that your money works harder for you. Submit your questions to dollarsandsense@theaustralian.com.au.