Creating a financial heritage for your children: Part 2
In Part 2 of our three-part Heritage series, Prudential explores some of the more technical aspects of creating a financial legacy for your children. Read Part 1, our Heritage Day article.
The first step in securing a brighter future for your children (or grandchildren, nephews and nieces) is deciding how to give. There are many options, including tax-free saving accounts and unit trusts in the children’s names, which all have their pros and cons. When choosing, you need to consider the most effective way to help, and what the taxman has in mind. And you also have to remind yourself not to take personal ownership of the investment.
Tax-free investments for the kids
The relatively new (to South Africa, at least) tax-free funds are a very good option. They’re primarily structured to encourage retirement savings and have similar benefits to retirement annuities in that there’s no tax within the fund, including taxes on capital gains, interest or dividends. The ongoing tax savings within the fund can be thought of as an additional fund from which to earn compound growth – a very significant benefit over the long term.
Another positive feature is that these funds are not bound by Regulation 28 (which limits the allocation to local and offshore equity and may therefore have a negative impact on growth in the long term, creating additional risk). As the investments are for young people, ‘time in the market’ is on your side, so you can safely select a tax-free savings fund that assumes more risk for potentially greater returns.
One final benefit of investing in tax-free funds is that fund managers are not allowed to earn performance fees, which aligns growth benefits between fund managers and the investors, your children.
The nitty gritty:
- You’ll need to set up the account in the child’s name.
- You can invest R33,000 per year per account as monthly contributions or in a lump sum.
- The lifetime contribution limit is R500,000 per account. This means that it will take about 15 years of giving to reach the full contribution cap per account.
- You don’t have to commit to these contributions, and withdrawals from the funds are allowed. However, if any funds are withdrawn before you reach the maximum of R500,000, you won’t be able to replace them – you can only contribute a net R500,000 per person.
- If you set up the fund early enough, it could provide your children with the much-needed capital for a university degree, first car or home deposit.
Unit Trusts for the kids
You also have the opportunity of investing in a portfolio of unit trusts in your children’s names. This choice offers greater flexibility than tax-free funds as there are more funds to choose from. You may, for example, choose funds with a 100% offshore allocation because the long-term time horizon allows you to bear such a risk.
On the plus side, there’s no limit to how much you can give per year and there are no repercussions should funds be withdrawn. But you do lose the (significant) benefit of tax-free growth.
If you have sufficient wealth, why not give to your children (or other important children in your life) via a combination of tax-free funds and unit trusts? Once you’ve given the annual limit of R33,000 to the tax-free savings fund you could then invest an additional amount into unit trusts.
No way around the tax man
An easy way to avoid paying estate duty would be to give all your assets away during your lifetime. But the taxman prevents this by applying a 20% donation tax on all amounts donated that exceed the annual exemption of R100,000 per spouse.
Donations include contributions to a child’s tax-free savings account, a portfolio of unit trusts in his/her name, and other gifts including school or university fees. The taxman even prevents parents from undervaluing assets (such as a house) when selling to their children.
If you invest in unit trusts, you won’t be able to benefit from lower tax rates that apply to children who haven’t started to earn yet. The capital gains tax, interest, and dividends will be taxed in your name until the child turns 18. Once your child turns 18, then he/she is responsible for paying the tax. The rules are different if you’re a grandparent, aunt or uncle. In these instances, the child bears the tax responsibility regardless of his or her age.
If things don’t go according to plan and your financial circumstances change, you can transfer investments in your children’s names to yourself – provided the children are younger than 18. Hopefully, this will never be necessary.
Once your child has reached the age of 18, he/she is in charge. If they want you to continue to manage the investment, they will have to give written permission to the investment manager allowing you to access funds and to make decisions about the asset allocation.
Other ways to give
As well as growing financial capital for your family, remember that you can also nurture intellectual capital through education and experience, and social capital by giving to the community.
There’s nothing more liberating than giving freely and truly expecting nothing in return. Experience the feeling by investing for your children or grandchildren during your lifetime.
Prudential has an array of Tax-Free Unit Trust options, including the Prudential Dividend Maximiser Fund and Prudential Enhanced SA Property Tracker Fund. These are both good ways to give to your children as they’re geared for long-term investment horizons and capital growth.