- Every parent wants to make sure their child’s dreams will come true
Benjamin Franklin said, “An investment in knowledge pays the best interest.” In South Africa the investment in knowledge – or education, comes at a premium for young parents. So, the best advice to any new parent, is to start saving and investing as early as possible. Leaving it until the child is ready for school will make better or more expensive schools unaffordable for most.
Duann Cronje, Certified Financial Planner at Fiscal Private Client Services says that more and more parents are asking how to invest on behalf of their children. Generally, these parents are concerned about the cost of making their child’s dreams come true – so he sets about answering some common questions.
What are you saving towards?
“An important first question, is how will these funds be used? Are they intended for school fees, university education, a car when they reach 18, a down payment on a house or flat when they start working, paying for a wedding, or to give them a head start on their retirement savings?” asks Cronje. This will inform the advice and decision, as well as the amount that could be contributed to the savings each month.
“If affordability is an issue, the priority should be the ‘what’ you are saving for; and then contribute towards that first. Time is your friend and the earlier you start the better,” explains Cronje.
Which investment vehicle suits your needs?
The most common vehicles to invest into for your child would be a Unit Trust or Tax-Free Savings Account (TFSA), even though there are several different options to consider. Every vehicle has different benefits and underlying rules (which includes accessibility) and choosing the correct vehicle will provide you with long term benefits.
A minor child in most cases will not be liable for income tax and therefore any growth or contributions will be taxed in the hands of the parent until the minor reaches the age of 18. Once the child reaches the age of 18 the tax burden will change and now be for their expense. If no other income is earned when they reach 18, this could mean that the tax liability could be minimal (if any) as they would likely fall below the tax threshold. This ties back to why the funds were needed in the first place and should again drive any advice or decision.”
Let us consider an example.
John is 35 years old and wants to invest R30 000 for the benefit of his only child, Jane, who is 5 years old. How would this investment impact John or Jane’s tax affairs if he were to invest into a Unit Trust or a TFSA?
Section 7 of the income tax act states that income shall be deemed to be received by the parent of any minor child or stepchild, if said income is accumulated for the benefit of the minor child or stepchild, by reason of any donation, settlement, or other disposition. Therefore, the R30 000 investment in Jane’s name would be seen as a donation received from John. This falls below the R100 000 allowable donations tax exemption, so no donations tax will be payable in this example. As Jane is a minor, the growth on this investment will be attributed to John until she is 18 and a taxpayer in her own capacity. For example, if the fund were to declare dividends of R2 000 and interest of R2 000 per annum, both will be included in John’s taxable income. Additionally, if the fund grows to R100 000 over time while Jane is still a minor, and John decides to withdraw the capital for whatever reason, any capital gains tax would fall due on John too.
As above, the R30 000 investment would still be seen as a donation from John. However, within a TFSA there is no income tax, capital gains tax or dividend withholding tax payable, thus John would not incur any of these tax liabilities. The downside here is that he will be using part of Jane’s lifetime TFSA contribution limit of R500 000. It is important to note that we are only allowed to invest a maximum of R36 000 into a TFSA every year without incurring a penalty tax, and contributions higher than this amount will be taxed at 40%. If the parent would like to contribute more than the allowable amount and pay a tax penalty, it would be advisable to talk to a tax practitioner before making any contributions.
So, what happens if the amount invested on behalf of the child is higher than the R100 000 allowable donations tax exemption?
John would be liable for donations tax on any donations higher than R100 000, taxed at 20%. If he were to invest R200 000 in Jane’s name, he would need to pay an additional R20 000 in donations tax (R200 000 less the R100 000 exemption, taxed at 20%) to SARS by the end of the month, following the month in which the donation was made.
Choosing an investment vehicle that is inappropriate could have an adverse effect on attaining your goals. It is also advisable to check the minimum amounts for debit orders/lump sum additions or contributions for each investment vehicle, investment house/manager and underlying fund, as they could differ.
Cronje explains, “Once you have ascertained the aim, investment vehicle, affordability, and tax consequences, you must agree on how much risk is appropriate. If you are saving over the short term, which in most cases doesn’t make too much sense when saving for your child, investing into shares will not be appropriate as they could be too volatile over the short term, and you could end up having a lower value than the amount you invested. Again, the opposite is also true. If you invest for a 20-year+ period, keeping all the funds in cash will more than likely give you less purchasing power than what you were hoping for. The risk you are willing to take when investing, the risk you need to take to reach your goal, and your ability to take on risk, should all be considered before deciding on the underlying fund/assets.”
When an investment is made on behalf of a minor, it’s wise to update your will to reflect any changes that are put in place, if they have an impact on the bequests in your Will. “In fact, whenever there are changes in your life that will affect your financial planning, you should be updating your Will,” concludes Cronje.