Investing for the grandchildren

When you start investing early in a child’s life, the money has years, maybe decades, to grow. Thanks to compound interest and growth, even modest contributions made when your grandkids are young can turn into a substantial sum by the time they’re adults. It’s also about imparting financial wisdom. As they grow, seeing an investment account or bond set aside for them can spark conversations about saving and investing. It’s an excellent way to teach them about money and show how small contributions add up over time. Plus, it’s a meaningful legacy: you’re helping tangibly secure their future.

Before diving into specific investment options, it’s essential to know why a special approach is needed when investing for minors. In Australia, children under 18 have very low tax-free thresholds for investment earnings. This means that if you simply open a bank account or invest in their name, any income, such as interest or dividends exceeding approximately $416 per year, is taxed at very high rates, potentially up to 45% or even higher on specific amounts. These rules exist to prevent adults from shuffling money into a child’s name just to save on taxes, but it also means your grandchild’s investment earnings can be severely eaten away if not structured properly.

Essentially, putting investments directly in a grandchild’s name can be tax-inefficient unless the amounts and earnings are minimal. There are tax-effective ways to invest on behalf of your grandchildren that sidestep these punitive tax rates. James recommends examining special investment vehicles designed for situations like this.

One of James’s favourite tools for investing for kids is the investment bond, also known as an insurance bond. Investment bonds can be a real winner for grandparents because they’re simple and tax-effective for long-term savings.

Here’s how they work in plain English:

• Tax benefits: An investment bond is similar to a managed fund, offering a tax shelter. Any earnings, interest, dividends, and capital gains inside the bond are taxed by the bond provider at a flat rate of 30%. As the investor, you don’t have to declare these earnings on your tax return each year. If you’re a grandparent on a higher tax rate than 30%, this already works in your favour. And if you hold the bond for at least 10 years, you can withdraw the money completely tax-free at the end. The 10-year rule makes bonds ideal for long-term goals – which is exactly the timeframe we’re looking at for our grandkids.
• Set-and-forget simplicity: Investment bonds are relatively hands-off. You can contribute a lump sum or make regular contributions; there’s a special 125% rule that essentially allows you to add to it each year within limits without resetting the 10-year tax-free clock. Once it’s set up, the funds are invested in the options you choose, and they grow over time. You don’t need to worry about yearly tax paperwork.
• Flexibility and access: Although you ideally want to keep the money invested for 10+ years to get the full tax benefit, you’re not locked in as you would be with superannuation. If circumstances change, you can usually withdraw earlier; however, you may incur some tax on the earnings if you do so before the 10-year mark, with tax offsets available to avoid double taxation. Many investment bonds also let you nominate your grandchild as a beneficiary, or even a specific age at which they receive the funds.
• No under-18 hassles: The bond is technically an investment in your name, or it can be held in a trust or child advancement policy, so it doesn’t trigger minor tax rates. When the time comes to hand over the money, it can be transferred or paid out to the grandchild quite smoothly.

An investment bond is a “no-fuss” way to invest for grandkids. You contribute money, it grows in a tax-friendly bubble, and if you’ve stuck to the rules, you hand it over tax-free for the child’s benefit down the line. It’s easy to see why this option is popular for many Australian families.

Education bonds are a close cousin of investment bonds, offering an additional benefit if the funds are used for education. If your goal is specifically to help pay for your grandchildren’s schooling or university costs, an education bond might be worth considering.

Just like a regular investment bond, an education bond’s earnings are taxed internally at around the 30% rate, and typically won’t bother you at tax time personally. They usually have the same 10-year tax-free rule. Suppose you withdraw money to cover approved educational expenses, such as tuition fees, textbooks, and other educational costs. In that case, you may be eligible for a tax benefit or rebate that effectively refunds some of the internal tax. In other words, using the funds for education can make those withdrawals very tax-efficient, even before the 10-year mark has passed.

Education bonds let you maintain control. As the grandparent and bond owner, you decide when to withdraw and for what purpose. If the grandchild doesn’t end up needing all the funds for education, you can use it for other purposes or even roll it over to them later. Specialty providers offer these bonds and provide a range of investment options. They can be a great set-and-forget option if you prioritise education funding

It might sound a bit extreme, but some grandparents are even thinking 50 years ahead and contributing to a superannuation fund for their grandchild. While this strategy isn’t about helping with university or a first home, it can be an incredible long-term gift, setting them up for retirement. How would this work? Essentially, you can contribute money to a super fund on behalf of your grandchild, and minors can have super accounts, typically with the assistance of a parent or guardian during the setup process. The money in super gets the usual super tax benefits, generally 15% tax on investment earnings, and the balance can grow significantly over the decades, thanks to compounding.

The obvious catch is access. Any money put into a super fund is locked away until the grandchild reaches preservation age. This strategy is truly about their far future. If you’re in a financial position where you’ve covered more immediate needs, like education, and still want to give a further boost, contributing to their super early in life can potentially turn a small contribution into a massive nest egg by the time they retire.

There are annual limits to how much you can contribute to super without incurring tax penalties, and minors typically won’t receive the government co-contribution since they’re not earning income. It’s a niche strategy, but it’s indeed another tax-effective route since super is a low-tax environment. If your goal is ultra-long-term and you’re comfortable with the money being inaccessible to them until they’re older, this could be an option in your grand plan.

Aside from specialised products like bonds or super, you may consider investing the money in your own name with the intention of gifting it to your grandchild when the time comes. This is often the most straightforward approach. For example, you could open a separate managed fund or brokerage account earmarked for your grandchild, but hold it under your name. You pay tax on any earnings at your own marginal rate. Many grandparents are already in a lower tax bracket, especially if retired. In fact, Australian seniors often have access to tax offsets and a higher effective tax-free threshold. Additionally, franked dividends from Australian shares can further reduce tax. So, you might pay little to no tax on a modest investment portfolio held for your grandchild’s benefit, especially if your income is low in retirement.

The benefit is flexibility and control. You can decide when and how to give the money to the grandkids. When your grandchild is old enough, say 18 or 21, or has finished university, you can sell the investments and gift them the cash, or even transfer assets to them directly, though transferring shares can trigger capital gains tax for you at that point. Yes, there may be some tax to pay when you realise the gains, but if you’ve held the assets for over a year, you get a 50% capital gains discount, and again, if you’re in a low bracket, it may not sting much. This route avoids the complicated minor tax on yearly earnings because all the earnings were technically yours along the way.

What about using a trust? Some families establish formal trusts to hold investments on behalf of their children. A discretionary family trust can provide flexibility in distributing income to different individuals. However, trusts come with setup costs and admin. And importantly, if a trust tries to distribute investment income to a minor, those same penalty tax rates apply to the child’s share. Trusts can still be helpful if, for example, you want to retain control until your grandchild reaches a milestone, such as 25, or achieves some other significant goal; the trust can be written to specify conditions for distributions. Trusts are also common in wills, specifically testamentary trusts, to pass on an inheritance in a controlled manner. For investing during your lifetime, a trust might be overkill unless you have a large amount or specific control needs.

A note on social security: If you receive the Age Pension or other benefits, remember that money in your own name, even if “for the grandkids,” counts towards asset and income tests. Gifting large sums can also impact your pension; Centrelink has gift rules that disregard gifts above certain limits for several years. This doesn’t mean you shouldn’t invest for them, just be mindful of the rules so there are no surprises. An investment bond in the child’s name, with you as trustee, might be treated differently for Centrelink than money in your bank, for example. It can be worth checking the implications if you’re in that situation.

Investing for grandchildren involves both heart and strategy. Here are a few practical tips to make the journey smoother:

• Start early and contribute regularly: Time is your best friend. Even small, regular contributions can grow impressively over 10, 15, or 20 years. Setting up an automatic investment plan can help build the fund painlessly over time.
• Choose the right vehicle for your goals: Match the investment tool to your purpose. If you want flexibility and simplicity, investing in your own name or an investment bond is a good option. If education costs are the focus, consider an education bond. For an extra-long-term retirement boost, super contributions could be the ticket. It’s okay to use a mix of strategies, too.
• Keep an eye on fees and investment mix: Regardless of the option you choose, be mindful of costs and where your money is invested. High fees can eat into returns over decades. Many investment bonds, for example, offer a menu of investment options; try to choose a low-cost fund or diversified option. Given the long time horizon, consider a growth-oriented investment, such as shares or a balanced fund, as the ups and downs will even out over the years. That said, always invest within your comfort zone and risk tolerance.
• Communicate and educate: As your grandchildren grow older, consider involving them in the process. You don’t have to divulge all the details or amounts, but even explaining “Grandma and Grandpa have been investing some money for you since you were born” can be a teachable moment. When they reach their late teens, you can show them how their investments have grown and teach them the basics of money management. This helps ensure that when they do receive the funds, they understand the value of what went into building it.
• Review periodically: Check in on the investment every so often, such as once a year, to ensure it remains on track and aligned with your goals. Life circumstances can change, you can decide to use some of it earlier for a specific opportunity for the grandchild, or you can contribute a bit more. Adjust if needed. And of course, make sure your own financial needs are secured first; your retirement comfort comes before gifting, and a good plan for the grandkids shouldn’t put a strain on your day-to-day finances.

Investing for your grandchildren is a beautiful way to plan for the future. With the right approach, you can minimise tax, maximise growth, and create a lasting legacy that helps your grandkids thrive. From James Wrigley’s preferred investment bonds to other savvy options, such as education bonds and early super contributions, there are multiple strategies to explore.

The team at First Financial comprises financial experts who help hundreds of Australians retire well and make informed, intelligent financial decisions. We cover everything from retirement and financial advice, investment and wealth management, superannuation and SMSF, insurance, tax, aged care, legal and lending services. Contact us for holistic and rounded financial management strategies.

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