Compounding for the kids
Saving for children has the advantage of time, writes Martin Hawes.
Many parents and grandparents like the idea of using the power of compound interest for the children. After all, children really do have the time to make compound interest work. It may be a lump sum perhaps on birth, or regular contributions, but after 20 years or so, the contributions along with investment returns, can make a tidy and useful sum.
There are three important ingredients: some investable cash, good returns and plenty of time. If parents have some cash, they can invest for good returns - and time will do the rest to give children help when they will need it later in life.
Ideally, the money would become available in the child’s twenties. That is an expensive time. They often have tertiary education costs, need a car, and are probably thinking about how to purchase a house. A lump sum with these costs and considerations is perfectly timed.
However, although the principle is simple, there are a couple of practical difficulties. First, returns need to be good. This precludes simple bank deposits which will not give good enough returns for compound interest to work its magic.
Second, whose name will the fund be in? If it is in the parents’ name, the fund will be taxed at the parents’ marginal tax rate, which is probably high. If the fund is held in the child’s name, it will be taxed at a lower rate. But on turning 18, the fund belongs to the child and can be withdrawn and used for anything she likes without reference to mum or granddad (party at Kelly Browne’s anyone?)
This quandary of ownership can be solved by KiwiSaver. A KiwiSaver fund can be opened for the child, regular contributions made and it will be taxed at the child’s own rate. When the child hits 18 years and starts to work (including part-time), employer and government subsidies will be added to the fund which will give it a kick along. Grandparents and other family members may also make contributions as they wish.
The KiwiSaver fund can also be one with a good bit of risk to improve returns.
The only difficulty with using KiwiSaver like this might be that funds can only be withdrawn for a house purchase – they cannot be earmarked for tertiary education or any of the other costs which might come along.
However, this lock up of funds may be advantageous.
It is true there are conditions regarding withdrawal of KiwiSaver funds for a first house and also we have to acknowledge a risk that the rules may change. Nevertheless, I do think these potential difficulties are probably relatively minor compared to ease with which KiwiSaver can be used, the better returns, and the fact that savings are for something of great value, a first home.
Martin Hawes is the Chair of the Summer KiwiSaver Investment Committee.
He is an Authorised Financial Adviser and a disclosure statement is available on request and free of charge, or can be found at www.martinhawes.com.