Part Four: Special Considerations When Investing For Your Child
Welcome back! This is part four of Crayon’s mini-series on investing for your kids, where we’re exploring how it could work for your family and give you a few tips from our experts to make it easy, actionable and effective.
By this point, we’re starting to get into the fun stuff - like terms and conditions, taxes and investment vehicles…. (Don’t worry, the mention of these makes us yawn too!) But glossing over these details when setting up an investment for your child can come back to bite you. For this reason, we’ve invited Dean Anderson, CEO of Kernel Wealth, to co-create this decision playbook.
Decisions, decisions…
Let’s start where you left off in Part 3: deciding which of the three options was suitable for your family. Based on your choice, there are some subsequent decisions you’ll need to make, and that’s what we’re covering here. The diagram below is your reference point, and you may like to come back to it as we move through each of the decisions to be made.
If you’ve decided to go for stock picking, please jump ahead to the last decision: Who’s name will be on the account?
If you’ve decided on a fund, please read on to the first decision: KiwiSaver or a general investment fund
Decision: KiwiSaver or general investment fund?
Applies to: actively managed funds and passively managed funds
Many investment managers, both passive and active, offer their funds in two formats: a KiwiSaver fund and a general investment fund. The decision to pick one over the other often comes down to how you want your child to use the funds.
The NZ Government set up KiwiSaver to encourage Kiwis to invest for retirement. This intention means that your child can only access their KiwiSaver under limited circumstances: to buy their first home in New Zealand, upon their retirement, if they permanently leave New Zealand or in exceptional situations (e.g., financial hardship).
Why KiwiSaver: parents who opt for KiwiSaver typically do so because it eliminates the risk of their child spending the money unwisely when they come of age (e.g. “Hey, check out my new luxury sports car”). The restrictions around KiwiSaver also mean that if there were a change in family circumstances, you can rest easy knowing the money is secure in your child’s name and not at risk of a guardian accessing it unwittingly.
Furthermore, there is the added potential of tapping into the First Home Grant. If your child has been contributing a minimum of $1,000 per year to KiwiSaver for at least three years before they withdraw it to buy their first home, they can receive from the government:
Buying an existing home: $3,000 if they’ve contributed for 3 years, $4,000 if they’ve contributed for 3 years or $5,000 if they’ve contributed for 5 or more years.
Buying a new build or land: $6,000 if they’ve contributed for 3 years, $8,000 if they’ve contributed for 3 years or $10,000 if they’ve contributed for 5 or more years.
Keep in mind there are other conditions they have to meet (e.g., in the 12 months before they apply, they must have earned $95,000 or less before tax as an individual buyer). Also, there’s no guarantee this will be around when your tot turns eighteen.
Note: New Zealand children born to parents who are US citizens can face a KiwiSaver tax compliance bill costing upwards of $250 a year.
Why general investment fund: parents who opt for a general investment fund do so because they want their child to have full flexibility when it comes to how they use the funds - for their education, to travel overseas, to start a business etc.
Decision: listed or unlisted investment fund?
Applies to: actively managed funds and passively managed funds
KiwiSaver funds are unlisted, so this decision only applies if you’re setting up your child with a general investment fund.
A listed investment fund is one that trades on a stock exchange just like a share and they’re better known as Exchange Traded Funds (ETFs). An unlisted investment fund is not on a stock exchange.
When investing for your child, taxation is the main difference between NZ ETFs and unlisted funds. If your child earns little to no income - which is the case for most children - then the tax rate on their fund will be 10.5%. This is known as the Prescribed Investor Rate (PIR), and you can use this handy tool from the IRD to check for your child.
Taxation of ETFs: ETFs on the New Zealand Stock Exchange are structured as Listed Portfolio Investment Entity (PIE) funds and taxed at a fixed 28%. You can claim back this overpayment as a tax credit, but this is only useful if your child has other income to offset against this, which many do not. This tax leakage can add up, particularly if you invest for a long period of time for your child.
Taxation of unlisted funds: unlisted funds in New Zealand are typically structured as unlisted PIE funds. If you invest in one of these, your child will be taxed at their correct Prescribed Investor Rate (i.e. 10.5% if they don’t have other income sources).
There are other differences between ETFs and unlisted funds not specific to children, such as transaction fees, which you can read about here.
Note: your chosen investing approach may influence whether you invest via ETFs or unlisted funds. If you’re seeking a passive investment, you have a range of New Zealand ETFs and unlisted funds to choose from. In contrast, most active fund managers in New Zealand are unlisted.
There are many passive and active ETFs listed overseas, particularly in the US. Different tax rules apply to overseas ETFs, which you can read up on here.
Decision: Who’s name will be on the account?
Applies to: stock picking, actively managed funds and passively managed funds
This next decision only applies if you’re setting up a share trading or a general investment account. If you decide KiwiSaver is the way to go, then the account will be under your child’s name. If you put the funds in your KiwiSaver, you’ll only be able to access it when you buy your first home or when you retire - not ideal for your child!
The name on the share trading account or general investment fund account dictates:
How much control you’ll have over the account
How much tax you’ll pay on the investment
There are two common options: your name or your child’s name.
Option 1: your name
By opening the investment in your name (or contributing more to an existing investment in your name), you benefit from:
A high degree of control: you decide at what age your child is first given access to the funds, and you can choose to do it gradually. For example, you may want to gift them half the funds when they turn 18 and hold onto the rest for later. This can safeguard against reckless spending when your child is in young adulthood.
More flexibility: you can also draw on this investment to meet any unexpected expenses of your own, and if you have more than one child, you could set up one fund in your name and use the funds flexibly across all your children.
The downsides:
Generally less tax efficient: income from unlisted PIE funds will be taxed at your Prescribed Investor Rate, and income from stocks will be taxed at your income tax rate. Your tax rates are likely to be higher than your child’s tax rates since they typically have no income (you can check PIR rates here and income tax rates here)
Subject to claims: since the investments are in your name, they would be included in bankruptcy proceedings and relationship separation claims against you. If you pass away before you’ve given the funds to your child, your child may not receive the funds unless you specify it in your will.
Option 2: your child’s name
Generally speaking, when you open an account in your child’s name, you make all the decisions about the contributions, investment options and withdrawals until your child reaches a specified transfer age.
Investment providers differ in their terms and conditions for children’s accounts, so read their fine print before proceeding. The default transfer age generally ranges between 18 and 25 years old, and some providers give you the flexibility to choose within this range.
The benefits:
Generally more tax efficient: for unlisted PIE funds, your child will be taxed at their prescribed investor tax rate rather than yours, and their rate is likely to be lower
Safer from claims: since the investment is in your child’s name, it’s generally not subject to any claims on your assets.
The downsides:
No control once your child reaches the transfer age: they will have full control over the account, which means you run the risk that they withdraw all the funds and spend them on whatever they want
Less flexibility: all funds deposited in your child’s investment account are considered a non-reversible gift, i.e. it's theirs to keep. You can withdraw funds, but it must be for their benefit or use. If you have more than one child, you’ll need to set up an account for each child rather than having a pooled fund.
Lastly, if you have a discretionary family trust, you could consider putting the investments in the name of the trust. This can be an effective way to maintain control over the investment even after your child reaches adulthood and ringfence the assets from claims, but it does come with more admin. We recommend you speak to your lawyer or accountant about this.
Final words from Crayon
Regardless of your choices when setting up the investment for your child, as they reach their teenage years, it’s worth talking to them about why you’re building a nest egg for them and what you hope they will do with it.
This is not only an excellent opportunity to teach them about investing but also a chance to help them understand the sacrifices you’ve made to build an investment for them and to set expectations. This reduces the likelihood that they’ll spend the money frivolously or regretfully when they do gain access to the funds.
We're almost there for those who’ve been playing along! In Part Five of this series, we go through how to select the right fund for your child - and then you’ll be on your way.
Thank you Dean for your generous contribution to this article.
This is part of Crayon’s mini-series on investing in shares for your child:
Now for the important legal part: Investing involves risk. You aren’t guaranteed to make money and you might lose the money you start with. The information we provide is general and not regulated financial advice for the purposes of the Financial Markets Conduct Act 2013. Please seek independent legal, financial, tax or other advice in considering whether the content in this article is appropriate for your goals, situation or needs. The information in this article is current as at 27 October 2022.
All of our content is independent. Crayon exists to provide you with accurate and valuable information you can use to make smart money moves for your family. We work with people we respect, and all collaborations are unpaid.
Dean Anderson
Founder and CEO, Kernel Wealth
Stephanie Pow
Founder and CEO, Crayon
