I have a seven-year-old child, and a grandparent has gifted them €3,000 yearly. So I have €21,000 in a bank account gaining no interest for them. I know that I, or rather my child, is lucky.
I’m wondering have you any advice on a long-term investment for this money that allows €3,000 to be added annually? Also, I have a one-year-old starting to receive this same €3,000 annually, so I’m wondering can you help regarding a long-term investment location for that money.
I know state savings rates have gone up, but they’re very poor for a long-term investment even when the investment is small.
Ideally, I’d like this to be a joint account between a parent and child so the money is spent for the intended purpose in years to come! I wouldn’t like an 18-year-old to have access to that amount of money . . .
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Ms CD
The first thing to say is that you are certainly correct to want to make some more of this money than is possible by simply leaving it in a bank deposit account.
The second, and equally important thing to be aware of is that I am not a qualified financial adviser, and that is really what you need here. Worse still, the Central Bank, which regulates such things, would have something to say very quickly if I started dispensing specific investment advice such as which fund you should invest in.
Having said that, there are some pointers that can be given.
You’re correct that your children are lucky, but that’s no reason not to make the best use of that luck. The €3,000 you are referring to obviously comes to them under the small gift exemption. This allows anyone, such as a grandparent, to give up to €3,000 to any other person, such as a grandchild, each year without any tax implications for either party.
If this child’s grandparent has the good fortune to be able to give each of them €3,000 each year until they reach adulthood, it is a great windfall and certainly something that is worth investing most likely in one or other fund on the basis of specialist advice.
The trickier bit is access to the accumulated assets.
Bare trusts
One structure that is used by parents or grandparents who want to put money in their children or grandchildren’s names while retaining control of how it is invested is called a bare trust, or a simple trust.
This is certainly suitable in a case like yours where use is being made of the small gift exemption. You don’t want the sums to grow in your name and then be handed over in a lump sum to the child at a later stage when they will be discounted from their lifetime tax free limit, entirely undoing the benefit of the small gift exemption.
The basic rules of a bare trust are that money or other assets put into the trust cannot be reversed so you don’t put anything in that you, as the children’s mother, may need or wish to access later. Once lodged in the trust, the named beneficiary – one or other of your children as you will need to set up a separate one for each – is absolutely and solely entitled to them.
No one is suggesting that you put all your investment eggs on one single share, for instance, or even into the very volatile world of cryptocurrencies
Also, the bare trust cannot be revoked. It is set up for a named beneficiary and, once that is done, you are locked into the process for any funds committed to it.
You act as trustee, essentially the manager of the assets which will be held in your name for the benefit of one or other of your children.
The one drawback from your point of view is that under a bare trust, the beneficary is entitled to access the funds when they turn 18. But in my experience, most children of 18 are not interested in splashing out whatever cash they can access.
There are ways that you can extend the point of access beyond 18 through other types of trust arrangement but they are more cumbersome and costly and something you would certainly want to tax specific tax, legal and financial advice on before proceeding.
I would suggest that, for your purposes, the bare trust should suffice. In fairness, few 18-year-olds are minded to immediately splash around the sort of sums you are likely to be talking about here which they have the good fortune to have had accumulated for them. Sensible conversations around basic financial planning as they approach 18 should help.
Investment choices
Having agreed the structure, the next thing is where to invest. And, in practical terms, this is likely to be in one or more of the range of unit-linked funds available n the market.
One of the things that puts people off these kinds of investments is the sheer range of choice, and this is where it will be worth your while to talk to a financial adviser. Ideally, this would be a fee-based adviser capable of giving you advice across the sector without fear of compromise through links to any one provider or another.
However, in reality, it can be hard to find such people, as most brokers are connected (tied) to one or more providers. To be fair, there are fairly strong regulations to try to ensure that any advice you get is fair and transparent and, most importantly, suited to your investment goals.
The key thing they will need to know is your attitude to risk. The instinctive response from most people is that they want to be sure they are not losing the money they are investing, but the only way to do that is to lock it into a cash fund where it will neither gain nor lose face value – although you will be worse off due to inflation and any fees charged.
In truth, you need to take some risk in order to benefit from such investment and, given your timeline – between 11 and 18 years minimum – the truth is that most advisers would suggest you embrace this in order to give your investment its best chance to grow.
Over time, even modest differences in investment return can make substantial differences to the final pot
That doesn’t mean you need to be reckless. No one is suggesting that you put all your investment eggs on one single share, for instance, or even into the very volatile world of cryptocurrencies, but there are bands of risk that a broker will talk you through. These range from very low (cash) to very high (which might include limiting your investment to one volatile sector or a very small stock market such as the Irish one).
You are more likely to be looking at a medium-to-high risk band, ideally a fund that is fairly well diversified geographically and across different sectors and assets classes – stocks, property, bonds etc. Studies of returns have generally shown that you are better off investing in what is called a passive fund – one that follows an index or a set series of criteria automatically – rather than an actively managed fund, where the fund manager has discretion to pick particular stocks or other assets to invest in.
An advantage of passive funds is that the fees associated with them are lower than you will find with active funds. But ultimately, investments like these are all about tapping into the power of compounding.
Investment returns
Just to illustrate how such an investment might accumulate over time, I have taken a look at three “balanced” funds with different providers. I won’t say who they are. What interest me are the figures. These funds are generally categorised as mediium-to-high risk. Each provider has their own classification, but that description broadly covers it. I have also taken a lower risk fund for comparison.
Most importantly, I have not allowed for exit tax, which will be a factor for you and one we’ll come to later.
I have taken their annualised performance over the past 10 years and calculated what that would deliver over the longer 18-year window of saving that you are considering for your younger child. Each presumes that the €3,000 gift continues until they are 18, so that you will have invested €54,000 on their behalf.
The figures would clearly be different in the case of the older child, for whom you will start with a more substantial initial investment but have a shorter investment timeframe.
In the case of the best-performing fund, it is delivering a very creditable annual return of 7.9 per cent. Investing your €3,000 a year into this fund and rolling it up over time would deliver a fund of almost €114,500, or a gain of €60,500.
A different fund, with annualised growth of 6.6 per cent, would yield a return of €100,100, or a gain of €46,100 while the third fund, which has reported annualised gains of 5.8 per cent will accumulate an investment of €92,350, or a gain of €38,350.
There is not even a one percentage point difference between those last two examples and you can see how, over time, even modest differences in investment return can make substantial differences to the final pot.
Turning to the lower risk fund with a return of 3 per cent a year over the term, your €54,000 cumulative investment would grow to around €70,500, an investment gain of €16,500. That’s a long way short of the best-performing funds, but the key thing to remember is that it is also ahead of what your money will earn sitting in a bank deposit account or even in state savings.
Where you invest will be down to you and, most especially your attitude to risk. With the sort of timeframe that you are talking about with your children, most advisers will suggest that you should consider a reasonable element of risk to maximise returns because the timeframe is long enough to allow any short-term volatility to even itself out. But ultimately, it is up to you.
The higher the risk, the higher the potential return; but, equally, the higher the chance of things going wrong.
Taxation
Before I forget, as I mentioned above, exit tax will lower those indicative figures I presented.
Irish investment funds used to operate on a net basis, that is the investment gain was taxed each year. It was decided, under significant lobbying pressure from the industry, to move to a gross roll-up model where the investment gains roll over in the funds, enhacing the prospects of a better return.
But the Revenue Commissioners still need their share in tax. The answer was exit tax – a set rate of tax on the investment gain when you took the money out of the fund. The rate was higher than the original tax rate to reflect the longer time the Revenue had to wait for it.
You’re correct that your children are lucky, but that’s no reason not to make the best use of that luck
To avoid tax evasion, it was decided that where funds had not matured or been drawn down within eight years, the tax would be assessed on profit in the fund at that point and deducted by the fund manager on your behalf and paid over to the Revenue. You still pay exit tax when you finally withdraw the funds, but the Revenue assesses the overall investment gain, the tax due and the amount already taken in tax at each eight-year anniversary to arrive at a final bill.
The rate of exit tax has changed over the years but it is currently deducted at 41 per cent of the investment gain. Minister for Finance Michael McGrath has undertaken to review the tax under pressure from the industry, which says it is deterring people from investing their money that is instead languishing and losing value in deposit accounts. Quite when that review will happen is as yet unclear, though you’d hope it would have happened in time for any changes to kick in before the eighth anniversary of you investing on behalf of your children.
The rate is significantly higher than the 33 per cent you would pay in capital gains if you used this money to buy an asset – such as directly purchasing shares – and it became more valuable during your period of ownership. It is also greater than the 33 per cent charged in deposit interest retention tax (DIRT) on bank deposit interest.
