With the start of a new calendar year, parents often start to think about how to save for their children’s education. Raising children is expensive and requires good planning. Starting early can help take the stress out of meeting any savings goal – and children’s education is no exception.
The cost of education The amount spent on education will depend on the family’s income status. On average, a middle-income family spends around $49,000 on education for each child. The cost can be higher for private schools. And the costs are increasing. The average cost of education has increased by more than 60 per cent since the start of this century. Saving for children’s education uses the same principles as any savings strategy. The education purpose sets a savings goal and a timeframe and may also offer unique investment opportunities. Four steps to setting up a savings plan for a child’s education are:
1. Set a savings goal – decide what is being saved for (for example, secondary school or tertiary education) to establish how much is needed and when.
2. Set a budget – calculate how much needs to be saved each pay to reach the savings goal.
3. Choose an investment product – decide where to invest the money.
4. Work out whose name to invest in – consider investing in the name of the person on the lowest tax rate.
Education (schol arship ) funds
Education funds, which have unique tax concessions, are offered by several friendly societies and are specifically designed to save for a child’s education An education fund is similar to an insurance bond in that the company pays tax on earnings at the rate of 30 per cent. But if the money is used to pay education expenses, concessional tax rules apply to refund the tax paid. Education expenses include uniforms, travel costs, fees, books, living away from home allowance and residential boarding expenses. The earnings withdrawn are taxable income to the child, but if the child is under age 18 and withdraws less than $3000 ($15,000 for a child age 18 or older), no tax is payable.
This can make education funds a tax-efficient option, as the earnings can be effectively “tax-free”. The product features can vary greatly between providers, so it is important to understand the features of any product, including the amount returned if the money is not used for educational purposes (if, for example, the child dies or decides not to continue study) or if the client decides to exit the fund early. Some funds use a pooling arrangement to pay a scholarship; so if the child does not advance to that education level, only the money invested – with no earnings – is returned.
If clients still have a mortgage, then instead of investing money to reach their savings goal, they can make extra repayments onto their mortgage and draw back down when needed. This can be a low-risk and tax-effective savings method if a redraw facility is available. The downside of this strategy is determining how much the “savings plan” has accumulated, as interest earnings are not added to an account and there is not a discrete balance to monitor. This strategy requires savings discipline and clients may wish to keep a nominal set of records showing the deposits and interest saved in order to calculate how much they have saved towards their child’s education.
Other investment options
Any investment can be used to save for education. This can include bank accounts, unit trusts, direct shares or gearing strategies. The choice will depend on factors including the client’s savings capacity, investment timeframe and risk profile. An important decision will be whose name to invest in. As a general rule, this would be the person with the lowest marginal tax rate, but the decision should be based not just on tax, but also on control over the investment.
Investing in child’s name
Some investments, such as unit trusts, will generally not allow direct ownership by a child under age 18, but will need the investment to be held in the name of a parent in trust for the child. Investment earnings in the name of a child (minor) are taxed at higher penalty tax rates. The $1350 low-income-earners tax offset effectively allows a child to earn around $3000 tax-free. If the investment is expected to earn more than this amount each year, investment in a child’s name may not be tax-effective.
Before grandparents contribute towards the cost of a child’s education or provide a lump sum, consideration should be given to the impact on Centrelink benefits. If an investment is held in a grandparent’s name (even as trustee) it counts as an assessable asset and income for age pension purposes. If the money is invested by the grandparent in the name of the grandchild or parents, this is a gift. Gifts over $10,000 in a financial year (or over $30,000 within five years) are deprived assets and assessable for the next five years. If the grandparent pays the school fees, these amounts are also gifts; however, paying the fees each year may make it easier to stay within the annual gifting limits and lessen the impact on the age pension, compared to gifting a lump sum to invest for future school fees.
Teach children about money
As well as saving for education, parents can give their children a good start in life by ensuring they understand how to manage money and create a savings discipline. Children generally learn money values from parents. Some simple things a parent can do to teach children good money habits include:
• Earning pocket money – set jobs to earn pocket money.
• Savings plans – set rules, such as, the child must save half of the purchase cost for items they want (for example, game console).
• Start an investment plan – if a child has a part-time job, encourage them to save a portion of each pay into a bank account and consider buying shares or investing into managed funds as the amount builds up.
• Buy a small share portfolio for the child and encourage the child to monitor the performance and help with decisions to buy or sell.
• Teach the concept of tax – if a child has a part-time job, take a portion out of each pay as “tax” and invest this into a savings plan for the child.