“In what name should we hold our investments?” The answer depends on your personal circumstances and there is no one size fits all answer. In this article I’ll briefly cover things you need to consider and the most common types of investment structures and situations.
Tax savings are usually why people start talking to me about using a structure for investments. However, there are many more issues that you need to consider when choosing an investment structure.
- Who are you investing for? Yourself, family, kids, business?
- How long are you investing for? Are you saving for short term purchases, long term asset accumulation, retirement or kids futures?
- What type of investment is it? Is it cash, shares, property, bonds, business assets? Income producing vs growth assets.
- Is tax saving a priority? Do you need tax savings to help fund the holding costs of the assets? Will there be big capital gains in the future?
- Is asset protection an issue? For example, protection from business risk?
- What is your current financial position? Are you starting out or do you already have substantial assets?
- What is your income level? For instance, low vs high income levels within a family group, working and non-working spouse, or children under 18.
I work with clients to get to know their circumstances and work out the best investment structure to suit their needs. It might be basic, such as buying assets in your own name, or using a managed super fund. More complicated situations might use trusts, companies and self-managed super funds. Costs, admin work and complexity vary with investment structures, and this should be considered as well.
Invest in your Own or Joint Names
If you are starting off, are single or in a couple, and one or both of you have a lower income or are saving for short term goals, investing in your own names would probably be suitable. Advantages include:
- Low or no set up costs.
- Less tax considerations, due to lower income and short timeframes.
- Less complexity and admin work.
- Investing in the lower person’s name can save tax.
- Income can be split between you.
- If you are negative gearing, it might better to invest in the higher income earner’s name, to maximise tax deductions. Higher tax deductions now, however, are a trade-off for capital gains in the future.
- As your circumstances change you might consider other structures.
Invest using a Discretionary or Family Trust
Discretionary Trusts, often known as Family Trusts, are popular for holding investments as they are good for asset protection. The ability to distribute income from discretionary trusts to different beneficiaries also provides tax advantages compared with owning assets in your own or joint names. However, discretionary trusts are not perfect. Some disadvantages include:
- No or lower land tax thresholds in some states for property investments, hence higher land tax costs.
- Tax losses being trapped in discretionary trusts and not available to offset higher personal individual income levels. Not a good structure if assets are negatively geared.
- Set up costs for the structure and ongoing tax and accounting costs, compared with individual ownership.
- Future changes in tax law to reduce the benefit of profit sharing with beneficiaries, unless the cash distributions are actually paid to them.
Other Structures for Investments
Lesser-used structures include companies, unit trusts, hybrid trusts and partnerships. These structures are not so great for asset protection and have less tax concessions than discretionary trusts. Although, like everything, they do have their place and we use them a lot for business assets.
Investing for Retirement
Pretty much everyone becomes a member of some type of managed super fund as their starting point for retirement savings. Whether you have a corporate, industry, public sector fund or retail fund, they are all managed super funds. You don’t have to worry about the management of them.
The alternative to managed super is a Self-Managed Super Fund, SMSF for short. The main difference between a SMSF and other types of funds, is that the members of the fund are usually also the trustees. This means that the members are responsible for the running of the fund and compliance with super and tax law. The members also need to make all the investment decisions for the fund.
For most people, making decisions on investments and running a fund is not something they want to be bothered with. These people are better off with a managed super fund.
However, there can be very good reasons to change to a SMSF, including:
- Investment choice – if you want to make your own choices about investments for your retirement, then having your own fund lets you do this.
- SMSFs allow you to pool your super balance with up to five members. Usually it is family members, but it could be unrelated members if they wanted to buy a joint investment, eg business premises.
- Costs of running your fund can be reduced. The costs for a SMSF are usually fixed, such as accounting, audit and ASIC fees. As the fund balance increases, the costs generally reduce as a percentage of the total funds, compared with a managed fund, where the fees are charged as a percentage of the balance. SMSFs can be cost effective when you combine the balances of a couple or families. Note, this works as a disadvantage when a fund has a low balance. I don’t think it is worth starting a SMSF with less than $300,000, as the fees would be cheaper in a managed fund.
- You want to buy residential or commercial property. You cannot invest in direct or real property in a managed super fund.
- You want to run an investment gearing strategy with your super money. SMSFs can borrow to invest in assets, mainly residential or commercial property. If you are self-employed, buying your business premises could be a good investment for a super fund.
- Asset protection is a big advantage. Assets held in a super fund are generally protected from creditors.
Investing for Children
I love the idea of investing for your children, but is it really for them or you?
The biggest difference when investing in adults or children’s names is tax. A minor can earn $416 tax free. Then they pay tax at 66% on investment income from $417 to $1307, and 45% over $1,307. These tax rates are really a penalty to stop people splitting income with their children. Due to the high tax rates, very few investments are actually held in a child’s name.
Who the investment is for is also another issue to be considered. People often plan to save for future child-related costs, school fees or buying the child a car, rather than actually making investments for the child. Saving for future costs is really about finding a tax effective savings option for the parents. Making investments for the child is about structuring the investment so it can be transferred to the child when they turn 18, tax effectively.
If you are saving for future costs, you could consider the following options, which all include the parents paying the tax.
- Savings bonds (also known as investment or insurance bonds) are a product that is tax effective in the hands of parents or grandparents. You make an initial deposit and then ongoing regular payments. Tax is paid by the fund that holds the bond at 30% and after 10 years you get back the investment tax free. There are a few more details to be aware of, but tax is paid concessionally on the investment.
- An ongoing savings plan in the name of the low earning spouse, such as a regular purchase of managed funds, shares or exchange traded funds (ETFs). If bought in the name of a low-income spouse, income tax and long-term capital gains tax will be minimised.
- Pay extra off your mortgage to save non-deductible home loan interest payments, with the intention to redraw in the future for expenses. A good way to do this is to split the home loan and allocate an amount for future children’s expenses to be repaid faster.
If you are making an investment to be owned by the child in the future, the following could be ways to structure it:
- Set up an investment account in the name of the adult who will act as trustee until the minor turns 18. Then, the shares can be transferred to them via an off-market transfer. The adult pays the tax at their tax rate until the investment transfers. After that it is taxed in the hands of the child. This structure is good for direct shares, ETFs or managed fund investments. Tax is minimised if the adult is in a low tax bracket and children’s penalty tax rates are avoided.
- If you do have a family trust you could use it to buy investments notionally allocated to the child. The adult beneficiaries can get the distributions of income until the child turns 18, then income can go to them.
- Making super contributions for a child could be a very effective strategy to help them accumulate wealth for their retirement. While this is talked about, I would not recommend it due to the long-time frame required before they can access the money.
As a closing note, please speak with your advisor about your investment plans in advance. We can set up structures quickly when needed, but once you have signed a contract or bought an asset there is not much we can do to change the name of the owner.
By Alison Lacey, Chartered Account and Director of Ecovis Clark Jacobs
This article first appeared in the March 2023 issue of the News Bulletin, published by the Australian Dental Association.