Why ETFs are fantastic gifts for kids

Simon Brown, founder and director of JustOneLap.com.
Simon Brown, founder and director of JustOneLap.com.

Something I have long advocated is buying children and/or grandchildren exchange-traded funds (ETFs) for Christmas and birthdays. 

Now, I am not a total scrooge – of course you can give physical gifts on special days – but the rest of the potential spend can go to an ETF. 

This is always a great idea as it’s truly a gift that will last and give real benefits over time.

Crucially, I always suggest ETFs rather than individual shares as the latter requires managing them and potentially switching them over time, whereas a broad ETF can be bought and left until it is needed.

This always raises the question of how this process is practically managed.

The first question is if the ETFs should be bought in the child’s name or that of the guardian. 

As far as tax is concerned, this question is moot as any tax will accrue to the guardian (I’ll touch on tax-free investing in a moment). 

Opening an account for a child is easy enough; the parent or guardian does the FICA process and if the account is being opened with a financial services provider (FSP), there is no age limit. 

A real stockbroker account requires the child to be at least seven years old.

But I prefer to set up a single account for the kids in the guardian’s name for a simple reason. 

Assuming there are two or more children and they are of different ages, individual accounts will result in different returns due to timing of the purchases and this may create issues later on.

So a single account that all the children have rights to is preferred and they’ll split the money when the time comes.

As for whether to use a tax-free account or not, I do not recommend this route. While tax-free accounts are a great product, the concern is if the child then wants to use the money for their tertiary education, spending the majority (or all) of the money in their early twenties. 

If this happens they’ll still have benefitted from the tax-free nature of the account, but will lose the next 40-plus years of potential tax-free gains, which is when the real power of such an investment kicks in. 

If the intention is that the child does not access the money until they’re nearing retirement, then investing it in a tax-free account works. But in most cases the money will be used well before then.

Hence, I always suggest rather letting the children open a tax-free account when they start working and earning. 

This way they’ll get many decades of tax-free growth as opposed to only getting one or two decades before spending the money when they’re around 20 years old.

Importantly, if you do want to go the tax-free route, the account needs to be in the child’s name, otherwise you’re using the parents’ annual and life-time limits.

So, with all that in mind, here’s how I do it for my niece and nephew who are now seven and nine respectively: 

When my nephew was born we opened a new account in my sister’s name with a cheap provider and I contribute money every birthday and Christmas. 

Grandparents and others are also able to deposit money into the account and we buy the ETFs on these occasions.   

Another real benefit is that even though my niece and nephew are not even 10 yet, they’re aware of investing. They understand they own ETFs (although the intricacies of ETFs are beyond them) and that these are for when they’re older. 

I had thought they’d get grumpy with me for never giving them presents, but this has not been the case and they’re happy talking about their fancy investments. 

So we’re turning kids into investors at a very young age. 

This article originally appeared in the 7 September edition of finweekBuy and download the magazine here.

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