How to start buying shares for your kids or grandkids

Shares are truly the gift that keeps on giving, potentially providing dividends for years to come and generating welcome capital growth over time. With the festive season approaching, shares can be a handy stocking stuffer, but there are hazards to avoid when investing for others - especially minors.

While children can't trade shares themselves, it's never too early to get kids interested in money matters, and there are several ways for parents or grandparents to invest in shares on behalf of a child.

If you're looking at investing serious money, one option is to establish a discretionary family trust. This can provide tax benefits but it's a complex step that comes with upfront legal fees and annual accounting costs. So, it's not a cost-effective strategy if you just want to kick-start a pint-sized portfolio.

An easier and cheaper option is to open an online trading account with an adult acting as trustee for the child. With online broker CommSec for example, when you open a share broking account you'll be asked which type of account you'd like to apply for. By selecting 'Trust', followed by 'Minor' for the trust type, you'll be able to act as trustee for the child's shares. A similar account set-up is available with nabtrade.

The beauty of this approach, is that when a youngster turns 18, the shares can usually be transferred into a share account in their own name. This may mean filling out a 'change of ownership' form. But as there has been no change in the beneficial ownership of the shares, capital gains tax should not apply.

Alternatively, you can buy shares in your own name and transfer them into someone else's name through an off-market transfer. This involves contacting your broker or the company's share registry, explaining what you're after and completing some paperwork. A small fee (often less than $50) usually applies.

Watch the dividend trap

The more complex aspect of buying shares for someone else - particularly children, is the tax treatment of dividends.

Where shares are directly owned by a parent, or by a parent as trustee for a child, dividends should be included in the parent's tax return. This may push up a parent's income but the beauty of franking credits is that any additional tax is unlikely to be a big deal. That said, it makes sense for the shares to be held in the name of the parent with the lower income.

If the child is the owner of the shares, any dividends may need to be declared in a tax return for the youngster. This means applying for a TFN for the child, which is easy enough. The problem is that very high tax rates apply to investment income earned by minors.

To discourage parents dodging tax by putting investments in the name of children, minors can only earn up to $416 in investment income before tax applies. Investment earnings above this can cop a tax rate as high as 66%.

Assuming the shares you buy have a fully franked dividend yield of 4%, a child would need to own shares worth around $7250 before tax applies. That may not sound like much. But remember, over time the market value of the shares will (hopefully) grow, pushing up the value of dividends.

If you're not sure which is the best strategy for your situation, a quick chat with your accountant or tax adviser can put everyone's mind at ease.

A Dividend Reinvestment Plan can be worthwhile

Once the shares are underway, it can be worth thinking about a dividend reinvestment plan (DRP), especially for youngsters.

Not all companies offer a DRP, but among those that do, there can be some real pluses. It means swapping cash dividends for more shares - often at a discount, and without the cost of brokerage. For children, who are unlikely to need the dividend income, a DRP can really turbo-charge compounding returns.

The downside is that you'll need to keep good records. Each DRP brings additional shares at different prices and acquisition dates, all of which will be needed in the future for capital gains tax calculations.  Setting up a spreadsheet can help you keep track of the appropriate details, and store any notifications of dividends reinvested in case the Tax Office raises any queries.

Foster an interest

If you plan on buying shares for kids, aim to foster an interest in their investment. Sure, it can be challenging explaining the finer points of the sharemarket to a toddler.

But good money habits can be formed from a surprisingly tender age, and with encouragement your youngster could be the next Warren Buffet.

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