When relationships break down, child maintenance payments are often made from post-tax money. If this is a position you are facing, perhaps you might be interested in learning about a Child Maintenance Trust.
According to the National Centre for Social and Economic Modelling (NATSEM), the cost of raising two children is estimated at $812,000. For those in the 45% tax bracket, every $25,000 in child support costs nearly $50,000.
Just as alarmingly, children receiving payments of ‘unearned’ income, such as support payments can attract tax rates as high as 66%.
When a Child Maintenance Trust (CMT) is established, investment assets placed into the trust generate income toward meeting child maintenance obligations. CMT income is taxed in the child’s hands at adult rates meaning that children receiving benefits from CMTs can claim the tax-free threshold, currently $18,200.
Before a CMT can be set up certain conditions apply including:
· a marriage breakdown occurring,
· both parents consenting to the trust terms,
· the contributing parent must earn in excess of the income tax threshold.
Importantly, trust assets come under the child’s control at a date pre-determined by you, for example, when the child turns 18.
A clear advantage is that CMTs protect assets so should you become bankrupt or lose your job you can continue to meet your child support obligations.
Case study – Tania
When Tania was 13 her parents divorced. Tania lived mainly with her mother and her father’s child maintenance obligation was set at $4,000 per quarter. After seeking financial advice, Tania’s father considered a Child Maintenance Trust. A comparison of Tania’s financial situation was used to determine whether a CMT was appropriate.
If Tania’s father invested a lump sum of $50,000 at 4%pa, regular quarterly drawdowns of $4,000 could be made comprising $500 income and a return of capital (return of capital is tax free).
Taxed at adult rates, the CMT income would fall below the tax-free annual threshold of $18,200 therefore no tax would be payable.
Tania’s father set up a CMT that would vest in her name when she turned 18. If Tania got a part-time job while she received these maintenance payments, her wages would be added to the payments and provided the total did not exceed the annual threshold no tax would be payable.
Outside of a CMT, Tania’s support payments would pay tax at minor rates. As her payments would exceed $1,307 pa, they would be taxed at the flat rate of 47% ($7,520 pa based on income of $16,000 pa).
Wages attract adult rates but would fall beneath the tax-free threshold.
This has been a very brief introduction. It’s worth talking to your financial adviser about how CMTs might fit into your overall financial strategy as they are not for everyone.