Time is a key ingredient in investing, and our dependants are ideally placed to benefit from its magic. Consider starting an investment in your child’s name this Youth Month and ease their gateway to adulthood. Even small amounts compound over time, making a big difference to their choices when they cross the threshold. Odirile Sebolao investigates the options.
Much has been written about compound interest: earning returns today on the returns you earned yesterday, over and above the amounts of money you contribute. But Morgan Housel, partner at The Collaborative Fund and a former columnist at The Motley Fool and The Wall Street Journal, put it magnificently when he wrote recently, that “everything worthwhile in investing comes from compounding. Compounding is the whole secret sauce, the rocket fuel, that creates fortunes.”
Given a long enough period to work, compounding can dramatically multiply the value of your investment, so that less of your total investment will be from your contributions and more from growth. Investing on behalf of your children when they are young, adding to it when you can, and leaving it to grow until they reach adulthood embodies the long-term thinking key to investment success.
What are your options?
There are various products you can invest in on behalf of your children. Two popular options are described below. As always, if you are not certain what the best option is for you and your child, you should talk to a good, independent financial adviser.
Basic unit trust investment
You can invest in unit trusts on behalf of your minor children with a monthly debit order or start with a lump sum. This is a general-purpose investment, with different unit trusts suitable for short-, medium- and long-term investment goals.
Unit trusts provide you with easy and affordable access to financial markets. When you invest, you buy units in unit trusts of your choice. Your money is combined with that of other investors who have bought units in that unit trust. Experienced investment managers use the pool of money to buy shares, property, bonds, cash, or a combination of these, on local or foreign markets, depending on the type of unit trust you choose. How much your investment grows depends on the performance of these assets. You can buy more units whenever you want to, and you can leave the units to grow.
When you invest in a basic unit trust you pay tax on interest, at your marginal tax rate, dividends, taxed at 20%, and capital gains when you withdraw from the unit trust. Forty percent of the capital gain is taxed at your marginal tax rate, but your first R40 000 per year is exempt. You may invest as much as you like and withdraw whenever you need to. When you invest in your minor children’s names you must include the income and capital gains from their investments in your own tax return.
You can invest on behalf of your minor children in a tax-free investment account and benefit from tax savings on the investment return. Your investment will be into unit trusts of your choice and you will pay no tax on the growth of the investment (interest, dividends and capital gains), making this an ideal choice for long-term goals. The key restriction on this account is that you can invest a maximum of R36 000 per tax year and R500 000 over your lifetime. Breaching these restrictions carries a tax penalty of 40% of any amount you invest above the maximums.
It is important to be aware that if you invest in this product in your minor child’s name, the contributions will form part of their lifetime limit and cannot be replaced once they are withdrawn.
The beginning, not the end
While different religions, cultures and traditions have their own interpretations of adulthood, the average age around the world that children become adults by law is 18. This is the age that they become legally in control over their own actions and decisions, and their parents are no longer responsible for them. In South Africa, at 18 your child can vote, get their driver’s licence, buy a house and get married. When they reach this “age of majority”, they also, by law, get control of investments you have made in their name (unless the product is specifically structured otherwise).
Of course, if your child would like you to continue to manage their investment when they turn 18, this is possible. They will have to give written authorisation to the investment manager, giving you permission to access their investment and act on their behalf. If your child is happy to manage the investments, they need not do anything (other than provide the investment manager with any required documents). Either way, you will no longer be liable for the income and capital gains earned from investments you have made on their behalf: Your child will be required to complete their own tax return.
The investment journey does not have to end when you present the investment confirmation letter; your child can continue on this journey and the gift you have given can continue to give and continue to grow. Put simply, it is the beginning of a new chapter; one full of possibilities.