Funding your child’s education is a hot topic today with the spiralling costs of schooling.
Research conducted by The Australian Scholarships Group (ASG) on education costs, provides some food for thought. The research is based on a child starting pre-school today and suggests that opting for the private school route from Prep – Year 12, will set you back a cool $367,569 per child. Even if you decide on a government school for primary years and private for secondary, you will still need to come up with $244,822.
For most people, the task of finding room in the family budget to pay school tuition fees will be a difficult task. Many find coping with mortgage repayments, bills and living expenses challenging enough without suddenly finding thousands extra for school fees.
What this means is that some careful forward planning is required to make sure you have enough money to give you, and your children, the full array of options for education. You also need to give some thought as to which savings vehicle will suit you best.
1. Invest in your child’s name
Probably one of the simpler and easier methods is to open a bank account in your child’s name, although this method has its limitations…
|Anything over $1,307
SOURCE: Australian Tax Office
Children or minors can only earn a small amount of income before they are taxed through the roof.
This could be an option for early on when the savings balance is low; however, you need to pay attention as the balance increases to ensure the interest or income earned does not exceed the $417. So, if you had $10,000 in a savings account in a child’s name earning 4.00%, you would be getting close to the threshold.
2. Invest in the name of parent earning the lower income
If one member of a couple isn’t working or working part-time, chances are their marginal rate of tax is low. Therefore, holding investments or savings in their name may be of benefit. You would need to keep in mind any future plans for that person to return to full-time employment.
3. Use an investment bond
Investment bonds or tax paid bonds are available from a wide range of companies and are a popular choice for education funding. They provide a variety of investment options such as shares, property and fixed interest, that are not normally available to minors.
The reason why investment bonds are referred to as a tax paid investment is because any earnings get taxed at the company tax rate of 30% within the investment. As long as money remains invested for 10 years, the investment provider pays the tax on the investment earnings so you don’t have to report the earnings in your tax return. If you withdraw before 10 years, then you would need to include earnings in your (or your child’s) personal income tax return. However, you will receive a full credit for the tax already paid, so there is no doubling-up.
4. Saving in an offset account against home loan
Another simple, but potentially a very effective way of saving for education costs is through your home loan. An offset account allows you to make extra repayments into a bank account attached to your home loan. It operates much like a normal bank account with some special features. Namely, the amount you have in the offset account effectively reduces the loan balance the bank uses to work out your interest payable. For example, if you have a home loan of $300,000 with $100,000 in an offset account, the bank calculates interest based on only $200,000.
The money you have in an offset account is generating an after-tax return equal to the interest rate of your home loan. For instance, if your bank is charging you 6.00% interest on your loan, the funds in your offset account save you this rate of interest being charged. If you compare this to saving money in an ordinary bank account, the bank may (if you’re lucky) pay you 4.00% interest on your savings, from which you still need to pay tax. Let’s say your salary is $70,000 per year, your after-tax return on the savings account interest becomes just 2.70% after tax (tax at marginal rate of 32.50% is deducted). A tax-free return of 6.00% versus 2.70%, I know the path I would choose!
The key to using this option is discipline. Money in an offset account can often provide a temptation to use the money for other purposes; renovations, car upgrades, holidays etc. If you plan to use these funds in the offset account to save for education costs, then you must resist temptation.
5. Set up a family trust
A family trust is a tax structure that allows you to distribute investment income to family members to take advantage of lower marginal tax rates. It is definitely the most complicated option and one that needs to be approached with the most caution. You would only consider this option if you already have a large sum of money available to invest. Specialist advice is required for set-up and there are compliance costs to consider.
Which is the best of option for you?
The answer really depends on your situation. An offset account against the mortgage provides the best financial outcome in terms of a guaranteed rate of return. However, if you don’t believe you have the discipline to not touch the funds for the long-term, then perhaps a different option should be considered. An investment bond can be tax-effective, provide flexibility and be that separate pool of money for the purpose of funding education. Or, a combination of two or more options could work for your family.
My advice is to start early, work out how much you will require for education costs, how much you will need to save to get there and then select the appropriate savings vehicle. A good financial planner should be able to set you on the right path.