Three ways to save for your children’s education
About the author:
- Author name:
- By Terri Bradford
- Job title:
- Head of Wealth Management
- Date posted:
- 19 April 2021, 5:00 PM
We all want the very best for our children.
We know that a good education not only provides them with qualifications it also provides them with opportunities. Knowing they were given every possible chance to express themselves and learn is probably the best gift you can give a child or grandchild.
We also know that a good education can be expensive.
What education savings choices do you have to ensure your “investment” does not become a financial burden? We list three options below:
Listed Australian Shares
Investment in Australian shares, which pay fully franked dividends, is one option. Imputation credits currently provide a rebate of 30 cents in the dollar which means you pay less tax on your dividend income.
Shares are one of the highest performing investment sectors over the longer term; that is, five or more years, which is the typical time frame most people are considering for education funding.
It is important to note that children under the age of 18 are by law not able to enter into a contract. Therefore, in most circumstances the account is opened in the adult's name (i.e. one or both parents, or grandparents) as trustee for the child or children.
This is generally known as an "informal trust". From a tax perspective, it is important you seek professional tax advice to determine which type of ownership will provide the most tax-effective outcome for you and your child.
This is because the trustee, or parent/guardian, could be liable for income and capital gains tax liabilities as a result of presumed ownership.
The other drawback with investing in direct holdings is that you can't establish a regular "top up" scheme, or savings plan; unless you invest via a company’s Dividend Reinvestment Plan, if available.
Considering most initial amounts gifted to children are fairly modest it is hard to achieve cost-effective diversification without at least $50,000 to invest.
So placing small amounts in a choice of one or two or three companies leaves you exposed to a higher risk if one or more of these investments fails or underperforms.
Managed funds / Listed investment companies (LICs) / ETFs
To overcome the issue of diversification many advisers suggest using a managed vehicle for children's investments. An unlisted managed fund or a listed investment company (LIC) are popular choices.
The advantage for both of these types of investments is that a manager makes all investment decisions for the investor and handles all administration matters (including detailed taxation statements).
Managed funds are a useful investment tool because you can establish an effective regular savings scheme; starting with a modest sum, typically $1,000, and investing as little as $100 on a regular monthly basis.
This approach also takes advantage of the dollar-cost averaging principle to reduce the market timing risk associated with investing in growth investments such as shares.
From a tax perspective actively managed share funds do tend to deliver realised capital gains on a regular basis although this is probably less critical under the current capital gains tax regime.
For investments held for more than 12 months only 50% of any realised capital gain is added to your taxable income and taxed at your marginal tax rate.
LICs often show more transparent value than a managed fund. An investor can see this value in the listed share price whereas a managed fund has a more complicated buy and sell "spread" value and a longer redemption period when withdrawing funds.
LIC annual management fees can also be lower than annual managed fund fees. Unfortunately, as with listed shares, LICs do not offer regular savings schemes.
Exchange-traded funds, or ETFs, are becoming more popular and like LICs, provide the investor with an opportunity to access various markets with a smaller amount of money. ETFs are investment vehicles that provide exposure to a basket of shares, listed property, commodities or currencies.
They have a slight advantage over LICs in that they can be bought and sold for close to the value of the underlying asset (i.e. index).
This usually results in the ETF price very closely matching the performance of the index.
If the ETF’s underlying assets produces income, investors will receive regular income distributions. ETFs pass on this income untaxed and franking credits are also passed through.
Management fees are quite low compared to managed funds, ranging from as little as 0.15% to 0.8% for some international share offerings.
Investment bonds (Insurance bonds & friendly society bonds)
Investment bonds can be a useful vehicle when saving for education purposes. With many investments such as shares and unit trusts, responsibility for the payment of tax is passed on to the investor.
This means any profits or losses you make must be included in your annual tax return for the year in which you earn them. With investment bonds, earnings are retained within the investment funds and tax is paid by the provider.
Investors do not need to declare any income on their tax return until a withdrawal is made. If the investment is held for 10 years or more, there is no additional tax to pay. If funds are withdrawn before 10 years, the investor will receive a rebate which can be used to offset additional tax payable.
For this reason, investment bonds are a popular choice for education savings. Specific education savings funds are available, modelled via the investment bond structure, although provider choice is limited.
Education savings bonds are particularly designed for education expenses; however, some providers allow flexibility to use the bond for non-education expenses.
They are often cheaper than other alternatives, particularly where investments are restricted to cash or fixed interest. They can also be quite inflexible if your need for these funds change, so any decision to use them should be carefully considered.
Tax is paid by the bond provider at the rate of 30%. However, the actual tax rate can be lower due to franking credits if the fund invests in listed equities.
Tax benefits can be enhanced further for education related expenses as the tax is claimed back by the provider from the ATO and is included in withdrawal proceeds to the student.
Summary of education funding options
|Potentially fully franked dividends
||Generally can’t be invested in child’s name
|Imputation credits help offset tax
||Income may add to parent’s tax
|Economical size with brokerage costs is $3,000 parcel
||Higher % brokerage for less than $3,000 parcel
|Some shares have a Dividend Reinvestment Plan
||Can’t add to in small portions unless Dividend Reinvestment Plan
|Initial investment can be from $1,000 (usually $2,000 or $5,000)
||Generally can’t be invested in child’s name
|Monthly investment from $100
||Income may add to parent’s tax
|Reasonable entry fees for small investments
||Potential realised capital gains
|Excellent spread of underlying assets for small sum of money invested
||Fund manager fees vary
|Reinvestment available for distributions
|Easy to manage
|Tax paid by bond manager not investor
||Nominal tax rate of 30% may be higher than personal tax rate
||Tax will apply if bond is redeemed early
|Switch investments without capital gains
|No tax paid on withdrawal after 10 yrs
|Flexibility to use funds for other purposes
Find out more
The investment option you choose, should best match your investment objectives and risk profile.
Tax may also play an important role when deciding which investment strategy to use. In that regard, it is important you seek qualified tax advice before implementing your strategy.
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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.