The best way to give money to the family

As I sit down to write this commentary the Australian share market has just risen substantially. So despite the gloom in the mining we are seeing optimism shine through in our banking and other sectors. Shares are back in fashion and even BHP Billiton has recovered some ground.

For the last month or so I have been in Newfoundland looking after two grandsons. When you are in a place as remote as Newfoundland on the north-east coast of Canada you don't follow the day to day events with the same vigour. But you see your grandsons and you do think about future planning.

While I was away I received a fascinating email from a reader whom I have met personally. I would like to share the emailed letter and my reply which may help your strategic thinking when it comes to investing for the future: So here is the letter:

“Dear Robert, I am a regular reader and we met at a social function.

“I am hoping to gain some advice and investment options for our new born son. I am planning on putting aside some money from my grandmothers' estate and then regularly contributing small amounts over the years to help give him a start in life when he reaches 21 years of age. One concern is that if I use methods I am familiar with (term deposits, shares, online interest earners) it will require me to pay more tax. I am wondering if you can advise me of smarter alternatives to make the most of what I have for our son. Kind regards”

My reply

First of all I need to point out that I am not an investment advisor so what I am writing is a set of strategic thoughts and general advice.

I want you to revise your strategies before proceeding with buying an asset for your son when he reaches 21.

First you need to think about your own retirement. The worst thing that can happen to your son is to have parents who have not provided sufficient money for their retirement. In 20 years you will have a better idea whether you have sufficient funds. If you do then you can give him money. Imagine how he would feel having assets you gave him and watching his parents suffer. 

I am 74 and during my peak earning period (I am still writing) I put money aside for our future. We did not put assets in our children's' names. Rather the view of my wife and myself was that the best thing we could give our two children was a good education.

Then (and now) that usually involves a good private school, although sometimes you can find an excellent government school. We are returning from Newfoundland where the state system has a curriculum that does not match many other Canadian provinces. Private education in Newfoundland is therefore essential. The rate of change in our society is going to increase and by the time your son reaches his teens about half the current jobs will have disappeared globally. That means education is becoming even more important. And I think knowledge of Mandarin – the official language of China – is going to be very valuable.

So in Newfoundland we help a little with their education because rather than setting assets aside for our grandchildren we believe it's better to make sure they have a good education – exactly the same view we had with our own children.

But if you want to invest in a physical asset then think hard about the desirability of transferring that asset to your son when he reaches 21. It's a dangerous time in a person's life. Children of that age may be inclined to sell the asset and go on a holiday. Remember what I said at the start – if the asset is in your name you can decide whether your son is mature enough at 21. There is no way you can tell when children are young. 

Separately, it is always important to communicate plans: To read about how to have wealth planning conversations with your family you might read today's contribution from Barron's, How to talk money with the family.

But what sort of asset? Well, subject to one caveat, there are two types of asset I would consider – shares or property. I don't think I would invest in term deposits longer term. If you chose to go the shares route then rather than pick winners I think I would invest in one of our top listed investment companies (LICs) – Australian Foundation Investment Company (AFIC) or Argo or LICs favoured by Eureka Report's LIC specialist Mitchell Sneddon would be suitable. (To see the Eureka LIC model portfolio click here.)

But your son is going to need a dwelling so you might invest in residential property. You could buy a block of land but that would involve paying rates. Alternatively you might invest in a dwelling for rent and negatively gear the difference between the rental income and interest costs, rates, repairs etc against your own income. That reduces your tax. Grandma's money can be used to make up the shortfall in your income. And, of course that way the asset is in your name. Prices in the property market are elevated at present but over the longer term it will rise. 

Another option to consider is an investment bond which has a capped tax rate of 30 per cent which helps those on higher tax rates. When held for the full 10-year term, withdrawals are tax free in the beneficiary's hands.

An investment bond provides your son with access to a vehicle that can minimise exposure to the full minor tax rate of 45 per cent. Such an environment allows funds to be held until a more appropriate time when your son is subject to a lower income tax rate.

One more point: Whatever you do for the first born you must do for any subsequent children.

I hope all this is of help. Email me back with your thoughts.

Best wishes 

Robert.Gottliebsen@eurekareport.com.au