Paul’s ver­dict

An ex­change-traded fund of­fers tax ben­e­fits as well as flex­i­bil­ity

Money Magazine Australia - - CONTENTS -

Ex­cel­lent ques­tion, Nitin. In­vest­ment bonds al­ways strike me as a pretty an­cient in­vest­ment ve­hi­cle and are not my pre­ferred op­tion. The big is­sue is that they are not “to­tally tax free”. The cor­rect term is that they are a “tax paid in­vest­ment”. What this means is that the re­turns they earn each year are taxed at the cur­rent com­pany rate of tax of 30%.

Clearly, a sales­per­son or sup­porter of th­ese bonds could fairly ar­gue that a bond pay­ing 30% each year has a lower tax rate than you would pay if you in­vested in your own name.

Investing in the name of your son is not go­ing to be a great idea as mi­nors (those un­der 18) pay very high rates on “un­earned in­come”. I sus­pect that this is why you may be look­ing at an insurance bond. In your sit­u­a­tion, investing in an insurance bond to pro­vide an af­ter-tax pay­out for your son's ed­u­ca­tion in a decade or so is not the world's worst idea but I don't think it is the best ei­ther.

I do ap­pre­ci­ate that as a doc­tor you are likely to be in the max­i­mum tax bracket. We should also con­sider that if you are mar­ried it may be that your wife is a lower tax payer and the in­vest­ment could be held in her name as trustee for your son. But let's go with the higher taxed sce­nario and look at investing the $500 a month in your name as trustee for your son. I agree that an ex­change-traded fund is a good way to go, as also would be a low-cost in­dexed fund of­fered by a firm such as Van­guard. You will pay bro­ker­age fees each time you buy and sell ETF units so may be worth di­rect­ing your monthly sav­ings into an on­line ac­count and buy­ing once a year.

There is lit­tle argument that with a view of at least 10 years you should opt for a growth­style in­vest­ment. This type of in­vest­ment would be mainly in­ter­na­tional and lo­cal shares. Th­ese as­sets tend to gen­er­ate lower in­come, and in the case of in­ter­na­tional shares this would be close to zero. Lo­cal shares tend to pay franked div­i­dends with a 30% tax credit at­tached to the in­come. So my view is that even if the shares are held in your name the tax li­a­bil­ity would be low.

There would be no tax on cap­i­tal gains as I can't see any rea­son to sell the in­vest­ment un­til it passed to your son. And this is an im­por­tant point. Pro­vid­ing you in­vest in your name “as trustee” for your son, he is the ben­e­fi­cial owner. When he turns 18 you can trans­fer the in­vest­ment to him with­out any cap­i­tal gains tax li­a­bil­ity as he has al­ways been the ben­e­fi­cial owner.

So in my view this is the way to go. You would pay some tax on in­come re­ceived but this is not the main game. That is cap­i­tal growth, which would pass to your son un­taxed un­til he chooses to sell. I ex­pect his in­come, as a uni­ver­sity stu­dent, to be nil or very low, so sell­ing this in­vest­ment, in par­tic­u­lar if he did so over a num­ber of years, would be most un­likely to see any tax li­a­bil­ity.

All in all, in my opin­ion, this is a bet­ter and more flex­i­ble op­tion.

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