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It’s common for parents or grandparents who want to give children a head start in life to begin investing money on the kids' behalf from an early age. A nest egg that can accumulate for the child to draw on once they’re an adult. Perhaps they can use the savings to buy a car or to pay a deposit on a house.
That can be done by simply opening a savings account and accruing interest or, alternatively, by building up a portfolio of shares.
Depending on how the investment is structured, very different tax outcomes can be achieved.
To work out who pays the tax, it’s necessary to consider:
who provided the funds for the investment
who receives the investment income (be that interest or dividends), regardless of who the income is spent on
who makes the investment decisions such as in the case of shares.
When does a child pay or not pay tax?
For the child to be liable for tax in the first place, the income must belong to the child and the assets that produce the income must also belong to the child. Ways to indicate this include:
Assets are acquired or savings accounts are opened in the child’s name. A strong indicator is where the money in a savings account was actually earned by the child, for example, from a part-time job.
The child’s TFN is quoted.
The child has access to the funds and can use them as they wish.
Dividend income
Where dividend income belongs to the child and the child's total income from all sources is less than $416, no tax is payable and a tax return doesn’t need to be lodged.
Even if the child has earned less than $416 in a year, if some of that income is dividend income, they may wish to lodge a return to get a refund of franking credits on the dividends.
The child’s TFN should be given when the shares are acquired. This is to ensure that tax is not deducted by the payer at the 49% rate.
Interest income
Different rules apply to interest depending on whether the child is less than 16 years old or not, and whether the paying financial institution has the child’s TFN:
Child is under 16 years of age:
Earns between $120 and $420 interest income from their savings account:
If the financial institution has their TFN or date of birth, no tax will be withheld and the child doesn’t need to lodge a tax return unless they have other income that compels them to.
If the financial institution doesn’t have their TFN or date of birth, the financial institution will withhold 49% tax and the child will have to lodge a tax return.
Earns $420 or more interest income from their savings account:
If the financial institution has their TFN, no tax will be withheld and the child will have to lodge a tax return.
If the financial institution doesn’t have their TFN, the financial institution will withhold 49% tax and the child will have to lodge a tax return.
Child is 16 or 17 years old and earns $120 or more interest income from their savings account:
If the financial institution has their TFN, no tax will be withheld and the child may have to lodge a tax return if their income from all sources is $416 or more.
If the financial institution doesn’t have their TFN, the financial institution will withhold 49% tax and the child will have to lodge a tax return.
Irrespective of the age of the child, if they earn less than $120 in interest income, the financial institution will not withhold tax. A tax return will only be necessary if they earn more than $416 from all sources.
When does a parent or other adult pay the tax?
If the parent or other adult provides the original funds that are used for the investment and then receives the investment income to use as they wish (even if they decide to use it for the child’s benefit), the income is treated as belonging to the parent or other adult. It must be disclosed on their tax return.
Any capital gains or losses (for eg on share disposals) must be reported by the parent. If the income belongs to the parent, it will be taxed at the parents’ marginal rate.
For example, Wayne opens an account for his son by depositing $5,000. Wayne is signatory to the account because Jack is four years old.
Wayne makes regular deposits and withdrawals to pay for Jack's preschool expenses.
Interest earned from that account is considered to be Wayne's.
When would a trust pay the tax?
Often a trust will be formed to look after the funds invested on the child’s behalf. If there is a formal trust (eg a trust deed in place), investments should be made using the trusts’ TFN, otherwise tax will be withheld at 49%.
When a trust exists, the income would be reported by the trust in a separate trust return.
If there is no formal trust in place, income will belong to the parent (as above).
Bottom line
Tax rules are very complicated and can change without you knowing about it.
When it comes to kids' investments, whether or not a tax return needs to be lodged, who pays the tax… and at what rate, is determined by factors including the age of the child, the income earned and who receives the investment income.
To get the best out of investments, always seek financial advice from a licensed professional.
Go deeper:
Can you pay your super to your grandchildren?
Financial disclaimer
The information contained on this web page is of general nature only and has been prepared without taking into consideration your objectives, needs and financial situation. You should check with a financial professional before making any decisions. Any opinions expressed within an article are those of the author and do not specifically reflect the views of Compare Club Australia Pty Ltd.
