.png)
Our client's current situation.
James and Jennifer are both IT professionals, both earning approximately $200,000 p.a. each. They have one child together, Anna, who is 10 years of age.
Anna recently received an inheritance of $500,000 from a great uncle.
James and Jennifer would like to invest these funds to grow over time for Anna’s benefit in the future.
Ideally, they would like Anna not to be able to access her investment until she turns 25, by which stage she’d be mature enough to deal with her inheritance.
There are typically three main options for these funds to be invested, which are discussed below:
Option #1: Invest in Anna’s name
Given Anna is a minor, investing funds in her personal name will attract a high level of income tax payable.
TAX RATES FOR 2022–23 INCOME YEAR
Assuming a 6% earnings rate, Anna would receive $30,000 in assessable income in the first year. This would result in $13,499 payable in tax, leaving Anna with $16,501 which would be added to her investment balance.
Option #2: Invest in James and Jennifer’s names (jointly)
As James and Jennifer are already in the top marginal tax bracket, every dollar they earn from the investment will be taxed at 45%.
Again, assuming a 6% earning rate, James and Jennifer would receive $30,000 in assessable income ($15,000 each) in the first year. This would result in $13,500 ($6,750 each) payable in tax, leaving $16,500 to be added to their investment balance.
In 15 years’ time, when Anna is 25, they would need to sell down the entire investment portfolio in order to give it to Anna and they could potentially incur a significant capital gains tax bill at that time.
Option #3: Purchase an Investment Bond
Investment bonds are a tax-paid investment. Earnings are taxed at a maximum rate of 30%. The actual effective tax rate impacting the investment may be lower as a result of franking credits and tax offsets passed from the underlying investment options. Tax is paid by the issuer of the investment bond and earnings do not need to be included in your personal tax return whilst you remain invested.
By utilising an investment bond, James and Jennifer can establish a tax-effective investment for Anna’s future financial needs. It allows them to invest funds on behalf of Anna without being exposed to the penalty tax rates which would apply to investments held by minors.
James and Jennifer can nominate an age (age 25 in this case) whereby they would like the bond to be transferred to Anna. This is known as ‘vesting’. Up until the vesting age, James and Jennifer retain full control over the investment bond and can make changes as required. At Anna’s age 25, the balance of the investment bond is not subject to stamp duty or capital gains tax and is transferred to her in full.
In its first year, assuming the same 6% pa return, the investment bond would earn $30,000. This will be taxed within the investment bond at 30%, which would result in $9,000 payable in tax. Leaving $21,000 after tax being added to the balance of the investment bond.
If we look purely from a tax payable perspective, we can see that in this case, the Investment Bond structure is going to provide the best outcome for James, Jennifer and Anna. The table below illustrates a tax saving of $4,500 in the first year alone. Over a 15 year investment timeframe, the use of an Investment Bond will amount to a significant tax saving.
Year 1 tax payable $13,499
Investment balance
end of Year 1* $516,501
Year 1 tax payable $13,500
Investment balance
end of Year 1* $516,500
Year 1 tax payable $9,000
Investment balance
end of Year 1* $521,000
