Investment Bonds For Children

If you’re looking for a tax effective way to put some money aside for your child or grandchild, consider investment bonds.

Perhaps you’d like to give a 21st gift, or buy them a car, or help pay for higher education, or even a house deposit. Whatever your reason is for helping a child to get ahead financially, it’s also a great opportunity to talk with them about finance.

Financial sustainability is best modelled at home by parents or grandparents where children are watching and learning and later copying.

Compound Interest

The earlier you start putting money into an investment bond the better due to the power of compound interest. That’s where you keep the interest earned in the investment and the interest then earns interest. (Another learning opportunity for the kids here.)

We started investment bonds for both our younger children when they were aged 4 and 7 years old. Because compound interest relies on time, the 4 year old will end up having more money than the 7 year old!

Ideally, if taking out an investment bond for a child, the best time to start would be when they are still a baby.

An initial deposit of $1000 plus $10 a week every week from birth to 18 years old can have amazing results. You could potentially be giving a $23,470 gift.

A compound interest calculation for an investment bond with a $1000 deposit and $10 weekly payment resulting in a final payment of $23,470 at 18 years.
The power of compound interest

Have a play around with the MoneySmart Compound Interest Calculator to see how different regular payments affect the final total.

Recommended Investment Bonds

As I’m not a finance expert, I look at what the experts recommended.

Scott Pape, Australia’s Barefoot Investor, recommends three investment bonds:

  • Lifeplan’s NextGen Investments
  • Austocks Life’s Imputation Bonds
  • AMPs Growth bonds

Pape specifically writes in his book ‘The Barefoot Investor’ not to go anywhere near the Australian Scholarships Group aka ASG. He says this is due to incredibly high fees and charges.

Which Investment Bond Fund?

During the investment bond application process you’ll need to decide on which fund within the bond to deposit the money.

And guess what? It’s shares in a low cost index fund, the same as Pape’s recommendation for your personal superannuation fund. And the same investment advice given by the financial independence gurus.

Personally, we invested with Australian Unity Lifeplan Child Investment Bond. The fund chosen was a Vanguard Australian Shares Index Fund and a Vanguard International Shares Index Fund.

As I’m familiar with the Australian Unity Lifeplan Child Investment Bond, it will be the bond mentioned in detail for the remainder of this blog post.

Please do your own research to find the best investment bond for your situation. Remember to always read the Product Disclosure Statement (PDS). I’m not joking.

Who Owns The Investment Bond

The investment bond is made out in the name of the child. However, you keep full ownership and control of the money until they reach the age that the money is transferred over to them.

This means you can change your plans at any time.

If needed, you can change the age the child will receive the money. For example, they do not seem mature enough to handle money responsibly at 18 years. You could then change the transfer age to later.

Another change of plans could be if something has happened resulting in the need to withdraw the money for your own requirements. This can be done.

You may also transfer the investment bond to another child, if you chose to do so.

Although we don’t like to think about it, if the child dies before reaching the age of transfer, you’ll receive the investment bond money back tax free.

If you die before the child reaches the age to receive the money, the executor or administrator of your estate holds the investment bond in trust until the child reaches the age you specified.

Vesting Age

The ‘vesting age’ is just a fancy term for when the investment bond money is transferred over into the child’s ownership.

Using the Child Lifeplan example, an investment bond can be started anytime from a child’s birth to 16 years. However, the earlier the starting date the better and preferably before the child is 10 years old.

You also have full decision on the vesting age. As long as it is somewhere between 18 to 25 years old. (Remembering that you can change this age at any time.)

The transfer of ownership occurs automatically without incurring personal tax, capital gains tax, fees or charges.

This is subject to the investment bond being kept for at least 10 years and complying with the 125% rule – see below.

Taxation

Investment bonds are referred to as a ‘tax paid’ investment.

This is because any tax payable on the interest or dividends is paid at the company tax rate of 30% by the insurance company.

While the money stays in the investment bond it will not increase or add to your personal tax liability. You do not need to declare this on your yearly tax return.

Even if you are in a higher tax bracket than the company tax rate of 30%, the interest or dividends earned in the investment bond will still not affect your personal tax payable.

And if you keep the investment bond for at least 10 years (subject to the 125% rule, see below), the returns are tax free.

It is treated as a tax free return of capital – no capital gains tax payable.

125% Rule

Investment bonds have a funny requirement called the 125% rule.

For the first year of the investment, you can contribute as much extra money as you like.

Then for every subsequent year, you can only contribute up to 125% of the previous years contribution.

For example, during the first year you added an extra $10 every week to the investment coming to a total contribution of $520 for the year. The following year, you will only be able to invest up to 125% of the $520.

To figure out 125% of $520, you would type on a calculator 520 x 125% which comes to $650.

Paying less than 125% will not affect the 125% rule.

If you do break the 125% rule by adding too much money to the investment it resets the 10 year timeframe for the entire investment. This means the investment bond will not be treated as a tax free return of capital for another 10 years.

If you do not make any contributions at all during the year, this also resets the 10 year timeframe.

To keep it simple, remember:

  • You can add as much extra money as you like during the first year
  • For each subsequent year, only put in up to 125% of the previous years contributions
  • It doesn’t matter if you put less than 125% in, but make sure every year you contribute some money
  • Keep doing this for at least 10 years

Early Withdrawal

If you need to access the money within 10 years of starting the investment, you’ll be required to pay tax on any interest or dividends.

The tax you pay will be dependent on your income bracket, remembering that 30% has already been paid by the insurance company.

For example, if you currently pay 37% of your income in tax, you will need to pay a top up of 7% on the earnings part of the money withdrawn (as the company has already paid 30%).

Fees

Back to that lovely document called the Product Disclosure Statement (PDS).

You’ll need to find the PDS. It’s easy to find by doing a web search of the name of the investment bond you are interested in + PDS.

When looking at the PDS locate any establishment fees, contribution fees, withdrawal fees or exit fees. (Child Lifeplan has none of these.)

Look up management fees, administration fees and indirect costs.

This can sound all very confusing, but unless you find the amount of fees charged it will be difficult to compare investment bonds.

For example, the Vanguard Australian Shares Index Fund within the Child Lifeplan investment bond has management and administration costs of 0.78%.

Compare this to Australian Unity Property Income within the same investment bond. It has fees and costs of 2.06% which is a massive increase compared to the example above.

Thankfully, I found this comparison so much easier by sticking to investigating the three investment bonds recommended by the Barefoot Investor. And from taking his advice to invest in low cost shares index funds.

Summary

An investment bond for a child is a sustainable way to invest in their future.

Simply set up a regular saving plan, chose an investment bond with a low cost shares index fund, leave compound interest to do its thing – and then after 10 years transfer the money over capital gains tax free.

“You can kiss your accountant goodbye (you don’t have to declare the income).”

Scott Pape

Disclaimer: I am not a personal finance advisor. Do your own research and contact a professional as needed. Tread your own path

Cash Hippy

I'm an everyday person on a journey to save money and care for the environment at the same.

9 thoughts on “Investment Bonds For Children

  • June 17, 2019 at 1:56 pm
    Permalink

    Hi there,
    Super helpful. Thanks. Curious as to what per centage distribution you chose for the Vanguard International and Australian index funds. Did you go 50% for each?
    Cheers,
    Interested parent

    Reply
    • June 17, 2019 at 7:57 pm
      Permalink

      Hi Peter, thanks for the question. We did up deciding to go 50% each using the theory of diversification in the stock market.

      Reply
  • June 17, 2019 at 1:58 pm
    Permalink

    P.s. do you worry about the environmental and ethical harm caused by some of the businesses under the Vanguard index funds?

    Reply
    • June 17, 2019 at 8:05 pm
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      Fair enough point for any standard index fund tracking the index. I don’t think there is an easy answer here as there doesn’t appear to be a purely environmental or ethical index fund (I could be wrong though).
      On a side note, we could write to the businesses that make up the index and ask them to make more eco-friendly choices.

      Reply
  • June 23, 2019 at 4:58 pm
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    Thanks so much for your replies. It’s a challenge to weigh up a wish to invest for one’s child yet try to ensure their wealth isn’t built on pokie machines or labour exploitation, etc.

    I appreciate your thoughts and openness!

    Reply
  • July 26, 2019 at 10:40 am
    Permalink

    Under Taxation you say

    “Investment bonds are referred to as a ‘tax paid’ investment.

    This is because any tax payable on the interest or dividends is paid at the company tax rate of 30% by the insurance company.

    While the money stays in the investment bond it will not increase or add to your personal tax liability. You do not need to declare this on your yearly tax return.

    Even if you are in a higher tax bracket than the company tax rate of 30%, the interest or dividends earned in the investment bond will still not affect your personal tax payable.”

    Then…

    “And if you keep the investment bond for at least 10 years (subject to the 125% rule, see below), the returns are tax free.

    It is treated as a tax free return of capital – no capital gains tax payable.”

    …As I understand it, even after 10 years there is still tax payable, it’s just paid by the insurance company?

    Reply
    • July 27, 2019 at 6:52 am
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      Hi Baz, thanks for the question. The tax payable on dividends are paid for by the insurance company, and any capital gains after 10 years and subject to the 125% rule are tax free.

      Reply
  • May 17, 2020 at 8:25 am
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    Can you roll the bond over at the end of the term, ie add another 10 years without cost or penalty? You mention that if you invest above 125% it resets the term…is it simply a matter of investing more than 125% in the final year of the bond to reset it to year 1?

    Reply
    • May 19, 2020 at 9:16 am
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      Hi Paul, I’ve had a look at the Lifeplan Bond PDS that is mentioned in the article and it says that proceeds are tax-free to withdraw after 10 years, subject to the 125% rule. As long as an investor keeps to the 125% rule then the investment bond keeps going until vesting age, which can be set as anywhere from 10 years to 25 years. Please note, however, that I am not a personal finance adviser and recommend that you seek independent advice from a professional.

      Reply

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