We often work with families who have young children, and with one eye on the future it is a common goal to want to save for their education in years to come.
Investment returns play a part in selecting the right option but the right tax structure is also an important consideration.
Here are four strategies that you can consider for putting money away for the kids:
1. Paying extra into a mortgage redraw or offset account
This strategy wins the prize for simplicity and flexibility. A redraw or offset account against a home loan means that extra monies saved here reduce the interest payable on your loan.
Any investment you make to fund education has to be compared to the interest saved if you have a mortgage where you can put extra money into a redraw or offset. Your return will be the current interest rate on your loan, so with average rates around 5.00% per annum at the moment that certainly compares well with interest rates on bank accounts paying interest at around 3.00 to 3.50% pa.
The ‘return’ from interest saved is also an after-tax return. If you are in the 32.5% tax bracket, any other investment would need to earn 7.40% pa before tax just to come out even.
2. Education funds / scholarship plans
These funds & plans are usually set up as a specialist version of an insurance bond. The idea is that you make a regular contribution throughout the life of your child, to eventually be drawn on for their education.
Earnings in the fund are taxed at 30.0% pa and when the benefits are paid to your children it will count as taxable income.
One of the features of some education funds can be either a benefit or a drawback, depending on whether your child ends up pursuing post-secondary education that is eligible under the investment scheme. This feature is that if your child doesn’t undertake eligible post-secondary education, they will only receive the contributions paid into the fund over their lifetime, and none of the earnings. For children who do undertake eligible education, they share in the earnings forfeited by other members.
Certainly the greatest drawback of some of these funds is the complexity of the rules around what is and isn’t eligible study. For many, an apprenticeship won’t meet the requirements and university may not qualify if your children study part-time rather than full-time.
Because there aren’t that many providers of education funds & scholarship plans it’s usually a good idea to check out the investment fees – they may not be as competitive as other options.
3. Investment / insurance bonds
An investment or insurance bond is like investing in a managed investment, where your money is pooled with other investors. The main difference though is that the fund pays tax on investment earnings, you don’t put them in your tax return. The fund earnings are taxed at 30.0%, so you will need to consider whether this is higher or lower than your own personal tax rate if you were to invest in your own name.
If you hold the investment bond for 10 years, you don’t pay any tax on investment gains. Withdrawing between 8 and 10 years means you will pay tax on a pro-rata amount of the gains. You can also make up to 125% of the previous year’s contributions without resetting the 10 year period, so if you contribute $1,000 in year 1, you can contribute up to $1,250 in year 2 without restarting that 10 year period.
Another benefit of investment bonds is that if somebody else such as a grandparent, or aunt/uncle is making the investment on your child’s behalf, they can nominate your child as a beneficiary of the investment bond to make sure that they receive the money if the person contributing passes away.
While an investment bond looks and feels a lot like a managed investment, you should be aware that if you are unhappy with the provider, transferring your money to a different provider is the same as a withdrawal, so there could be tax payable if this is within the 10 year holding period.
4. Investing in the name of a spouse with lower taxable income
If one of the parents of the children will be staying at home to care for children, they may have a tax rate lower than the 30.0% that applies to earnings of an investment bond.
One of the benefits of investing in your own name is that it will give you the widest range of flexibility in terms of selecting an investment option that is right for you, you are not limited to just those offered by insurance or education bond providers.
For earnings up to $37,000 per annum (in the 2013/14 financial year) your tax rate is either nil or 19.0%, plus Medicare levy, so if one member of the family is going to be earning at this rate while they’re spending time raising children, investing in their name could prove more tax effective than the scholarship funds or insurance bonds.
What’s your plan?
As you can see there are some really good options to select from, depending on your personal circumstances. The most important first step though is just to have a plan in place, so that when the kids are old enough you’re able to help them out with education.
Consider it an education in your own future, a few dollars towards education means a fully fledged self sufficient adult child in the long run!
Give us a call on (02) 6247 1233 or email firstname.lastname@example.org if you’d like to start your own planning today.
(image credit flickr user joelogon)