Money invested directly in a grandchild's name is taxed at penalty rates once unearned income exceeds $416 a year, with tax rising toward 45% quickly. Investment bonds avoid this because the bond issuer pays tax at 30% internally, and proceeds become tax-free after 10 years if you follow the contribution rules. For larger bequests, a testamentary trust set up through your will lets income be taxed at normal adult rates.
Setting money aside for grandchildren is one of the most common and rewarding things grandparents do with their wealth — for a grandchild's education, a first car, a house deposit one day, or simply a head start in life. But the way the money is invested matters enormously, because of a specific and frequently-overlooked tax trap: children under 18 are taxed at penalty rates on "unearned" income — investment income such as interest, dividends, and managed-fund distributions — above a very low threshold. The first $416 of a minor's unearned income each year is tax-free, but above that it is taxed at much higher rates, rising to the top marginal rate of 45%, under rules introduced specifically to discourage adults from diverting investment income to their children (ATO, https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old). This means simply opening an investment or share account "in the grandchild's name" can see the child's investment income taxed at penalty rates above a small amount — a poor outcome that catches many well-meaning grandparents. The structures that work better include investment (insurance) bonds, often marketed as "child advancement" bonds, education savings plans, investing in the grandparent's own name and transferring later, or — for bequests — a testamentary trust. Each has different tax, Centrelink, and control implications. For retirees wanting to invest for grandchildren, the key is to avoid the minor's penalty-tax trap and to match the structure to the goal, the timeframe, and how much control they want to keep.
What's the motivation behind investing for grandchildren?
The motivation is straightforward and admirable. Grandparents want to give their grandchildren a head start — funding education, helping toward a first car or house deposit, or simply building a nest egg for them. It is a purposeful way to transfer wealth to the next generation, and one that lets the grandparent see the benefit during their own lifetime. The wish is common and well-intentioned, but the structure choice is frequently not well understood, and getting it wrong — most often by investing "in the child's name" — can needlessly hand a chunk of the returns to the tax office.
What is the minor's penalty-tax trap?
The single most important thing to understand is the minor's penalty-tax trap. Children under 18 are taxed at penalty rates on unearned income — investment income such as interest, dividends, and managed-fund distributions — once it exceeds the small $416-a-year tax-free amount, with the excess taxed at much higher rates up to the top marginal rate of 45%, a deliberate measure to discourage adults from splitting investment income to their children (ATO, https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old). So the common instinct — opening an investment account or share holding in the grandchild's name, or with a parent or grandparent as trustee for the child — exposes the investment income to these penalty rates, a poor outcome for anything beyond trivial amounts. Some income is "excepted" and taxed at normal adult rates — for example income a child receives from a deceased estate, or from a testamentary trust generated from the property of a deceased estate (ATO, https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old) — but ordinary gifted investments are not. Avoiding this trap is the starting point for investing well for grandchildren.
How does an investment (insurance) bond work?
The structure most commonly used to sidestep the trap is the investment bond, often called an insurance bond or a "child advancement" bond. With an investment bond, the bond issuer — a life insurance company or friendly society — pays tax on the bond's earnings at the corporate tax rate of 30% along the way, so there is no annual tax return and no minor's penalty tax for the child (MoneySmart, https://moneysmart.gov.au/glossary/investment-bond). If no withdrawals are made in the first 10 years (and provided each year's contributions stay within 125% of the previous year's), no further tax is payable on withdrawal — the proceeds come out tax-free (MoneySmart, https://moneysmart.gov.au/glossary/investment-bond). Many bonds also offer a child advancement or transfer option, allowing ownership to be transferred to the grandchild at a nominated age — say 18, 21, or 25 — with the grandparent retaining control until then; the exact terms vary by product, so they should be read carefully. Because the bond is tax-paid by the issuer at 30%, it is particularly effective for a grandparent whose own marginal rate is higher than 30%, and the structure suits the medium-to-long horizons (10 years or more) typical of investing for young grandchildren. For many grandparents, the investment bond is the natural choice.
What about education savings plans?
Education savings plans (scholarship plans) are a more specific option. They are structured for education costs, often with tax concessions when withdrawals are used to fund education — earnings are taxed concessionally and education benefit payments may carry tax advantages. The trade-off is that these plans can come with restrictions (the money must generally be used for education) and fees, so the product disclosure needs to be read carefully. They suit the situation where the specific goal is education and the plan's terms genuinely fit, but they are one option among several, not automatically the best.
Why invest in the grandparent's own name?
The simplest approach is for the grandparent to invest in their own name, and it can be surprisingly tax-efficient in retirement. The grandparent invests in their own name and earmarks the money — informally, or via their will or a letter of wishes — for the grandchild. The income is taxed at the grandparent's marginal rate, which in retirement is often low or nil once the tax-free threshold and the seniors and pensioners tax offset (SAPTO) are taken into account, so this can be more tax-efficient than it first appears. The grandparent retains full control: they can change their mind, access the money if they need it, and decide when and whether the grandchild receives it. The trade-offs are that the money remains the grandparent's assessable asset for the Age Pension (counted in the assets test and deemed under the income test), and that it only reaches the grandchild when gifted (within the gifting limits) or bequeathed later. For a grandparent with a low retirement tax rate who wants to keep control, the own-name approach is simple and effective — provided the intention is documented so the money actually reaches the grandchild.
What role can a family trust or testamentary trust play?
Trusts are relevant in specific cases. Where a family discretionary trust already exists, it can distribute to grandchildren — but lifetime distributions to minor beneficiaries are caught by the same penalty rates, so a family trust does not avoid the problem for young grandchildren. The important exception is the testamentary trust — a trust created by the grandparent's will. Income a minor receives from a testamentary trust that was generated from the property of the deceased's estate is "excepted income", taxed at normal adult rates with the benefit of the $18,200 tax-free threshold rather than the minor's penalty rates (ATO, https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old). This makes a testamentary trust a powerful structure for bequests to grandchildren (covered elsewhere), as distinct from lifetime gifts. Trusts add complexity and cost, so they are generally used where one already exists or is otherwise warranted.
How do Centrelink rules and control considerations factor in?
The Centrelink and control considerations round out the decision. Money the grandparent retains — in their own name, or in a bond they own — remains their assessable asset for the Age Pension. Giving money outright, to the grandchild or their parents, engages the gifting and deprivation rules: you can give away up to $10,000 in a financial year and $30,000 over five years, and anything above those limits is still assessed as your asset for five years (Services Australia, https://www.servicesaustralia.gov.au/how-much-you-can-gift). And control is a key decision: does the grandparent want to retain control (own name, or a bond transferable later) or give it away now? And at what age should the grandchild get access, because a large sum handed to an 18-year-old can be unwise, and concerns about the grandchild's or their parents' circumstances — immaturity, a child's divorce or bankruptcy — favour structures the grandparent controls until an appropriate age. Matching the structure to the grandparent's wishes about control and timing is as important as the tax treatment.
What do these choices look like in practice?
These two cases show investing for grandchildren in practice. They are illustrative only and not personal advice.
Helen, 70, wants to set aside $50,000 for her newborn granddaughter's future — likely education and a head start — to be available when the granddaughter is in her early twenties. Helen's instinct is to open a share account "in the baby's name". On these facts, Helen's instinct would walk straight into the minor's penalty-tax trap, because the share account's dividends would be taxed at penalty rates above the tiny $416 threshold, up to 45% (ATO, https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old). On these facts it is generally rational to consider an investment (child advancement) bond instead: the issuer pays tax at the 30% corporate rate with no penalty tax and no annual return for the child, the 10-year rule delivers tax-free access after a decade — well within Helen's roughly 20-year horizon — and Helen can retain control and have ownership transfer to her granddaughter at, say, 21 or 25 (MoneySmart, https://moneysmart.gov.au/glossary/investment-bond). Alternatively, if Helen's own retirement tax rate is low, she could invest in her own name and earmark the money via her will or a letter of wishes, keeping full control and bearing little tax, though it would remain her assessable asset for the Age Pension. Either beats the "in the baby's name" account; the key is steering Helen away from the trap and toward a structure matched to her goal.
Reg and Pat want to leave money to their five grandchildren, some still young, and want it protected and tax-effective — but they want to keep their capital available during their own lifetimes in case they need it. On these facts, because they want to keep the capital available for themselves and pass it on at death, a bequest structure fits better than lifetime gifting. A testamentary trust in their wills is powerful here: it can hold and distribute to the grandchildren after Reg and Pat die, and crucially, income a minor grandchild receives from a testamentary trust funded from the estate is excepted income taxed at normal adult rates rather than the penalty rates (ATO, https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/income-you-must-declare/your-income-if-you-are-under-18-years-old), making it tax-effective while also protecting the inheritance and controlling when young grandchildren receive it. On these facts it is generally rational to keep their capital available during life and use a testamentary trust via their wills, rather than investing in the grandchildren's names now (the trap) or locking money away in bonds they might need. This matches their wish to retain access while still providing well for the next generation — a job the testamentary trust does far better than a lifetime "in the child's name" arrangement.
For grandparents wanting to invest for their grandchildren, choosing the right structure is the difference between an efficient gift and one that needlessly leaks to tax. The work is to clarify the goal, the timeframe, and how much control the grandparent wants to keep; warn about the minor's penalty-tax trap and steer away from plain "in the child's name" accounts; compare the structures (investment or child-advancement bond, education savings plan, the grandparent's own name, or a testamentary trust for bequests); factor in the grandparent's own tax rate (often low in retirement) and their Centrelink position; address control and the age at which the grandchild gets access; consider the gifting rules if giving outright; document the intention where the money is held in the grandparent's name; and read product fees and restrictions carefully. The wish to give grandchildren a head start is a wonderful one, and with the right structure the money works hard for the grandchild rather than for the tax office. The single most valuable thing is to prevent the common "in the child's name" mistake and match a sensible structure to what the grandparent is actually trying to achieve.
Sources
- ATO — Your income if you are under 18 years old
- MoneySmart — Investment bond (glossary)
- Services Australia — How much you can gift
Key takeaways
- Money invested directly in a grandchild's name is taxed at penalty rates once unearned income tops $416 a year, rising to 45%.
- Investment (insurance) bonds sidestep the trap: the issuer pays 30% tax internally, and proceeds are tax-free after 10 years if contributions stay within the 125% rule.
- Investing in your own name and earmarking the money for a grandchild can be tax-efficient in retirement, but it stays your assessable Age Pension asset until gifted or bequeathed.
- A testamentary trust set up through your will lets grandchildren receive estate income as "excepted income" taxed at normal adult rates, not the minor's penalty rates.
- Gifting outright is capped by Centrelink's rules: $10,000 a financial year and $30,000 over five years before the excess counts as your asset for five years.
Frequently asked questions
Why shouldn't I just open a share account in my grandchild's name?
Because children under 18 are taxed at penalty rates on unearned investment income above $416 a year, with tax rising quickly toward the top marginal rate of 45%. A share account earning meaningful dividends in a grandchild's name can trigger a much bigger tax bill than expected.
How does an investment bond avoid the minor's tax trap?
The bond issuer, not the grandchild, pays tax on the earnings at the 30% corporate rate each year, so there's no annual tax return and no minor's penalty tax. If no withdrawals are made in the first 10 years and contributions stay within 125% of the prior year's, the eventual proceeds come out tax-free.
Does money I invest for a grandchild in my own name affect my Age Pension?
Yes. If you keep the money in your own name, it remains your assessable asset under the Centrelink assets test and is deemed for the income test, even if you've earmarked it for a grandchild. It only stops counting once you actually gift or bequeath it.
What makes a testamentary trust different from a normal family trust for grandchildren?
Income a minor grandchild receives from a testamentary trust funded by a deceased estate is treated as "excepted income" and taxed at normal adult rates, including the $18,200 tax-free threshold. Ordinary family trust distributions to minors during your lifetime don't get this concession and are still taxed at penalty rates.
How much can I gift a grandchild without it affecting my Age Pension?
You can gift up to $10,000 in a single financial year and up to $30,000 over a rolling five-year period without it counting against you. Anything above those limits is still assessed as your asset for five years under Centrelink's deprivation rules.