Parents want choice, flexibility, and an assurance they won’t be locked into a pre-determined future when looking at options for saving for their children’s education, but not all options offer these benefits, says Greg Bird, national business development manager at Lifeplan Funds Management.
“When it comes to education planning, parents want to understand how to provide a good education for their children, as well as what funding choices are available.
“Importantly however, they then want to make sure that whatever funding choice they select will not lock them into a pre-determined future.
“One of the problems with some education savings options is that they can only be used for a very narrow range of expenses.
“With education costs outpacing wage increases in Australia, parents need to be confident they are making the right choice when it comes to planning for their children’s future needs.
“Year in, year out, education costs continue to outstrip the pace of inflation, and the past 12 months has been no exception. While inflation, as measured by the CPI, clocked in at 1.5 per cent, education costs clocked in at 5.5 per cent*,
“This is an area of increasing concern to Australian families,” Mr Bird said.
There are a number of strategies to assist with meeting the future cost of children’s education, but most of them also have significant limitations.
“The simplest and most tax effective strategy is repayment of non-deductible debt, generally the home mortgage, so that this money can be redrawn for education expenses later. However this strategy requires extreme discipline and runs the risk of the funds being withdrawn to pay for lifestyle assets,” Mr Bird says.
“Another option is direct investment in the name of the child, but this also has its limitations. In most cases, the tax free threshold for children’s income is just $416 per year, and they are hit with a penalty tax of up to 66% on earnings once that threshold has been breached. Even a simple high-earning savings account could breach this threshold.”
A trust structure may also be considered as a funding mechanism for education costs, with the most common type of trust being discretionary family trusts.
“A family trust is a vehicle to accumulate investments with the earnings or profits distributed in the most tax-effective way. Essentially, a family trust allows people to exercise discretion when distributing funds to beneficiaries, however this may still fall under the confines of the minor’s penalty tax of 66%.”
Alternatively superannuation funds can be considered as a solution, as long as the investor has reached preservation age and has satisfied conditions of release.
“This window of opportunity will really only be of benefit to a very limited number of parents or grandparents. The other concern with using a superannuation based funding strategy is the regular changes made to superannuation legislation, creating a scenario of what works this year may not the following year.”
The approach that perhaps offers the most flexibility and the broadest range of features for education savings are investment bonds, which can vary in design, features and operation, Mr Bird says.
“Education funds that are classified as Scholarship Plans under Australian tax law have unique tax features not available with other savings and investment products. These funds are based upon an investment bond structure and can be used for a broad range of educational related expenditure at any age or level of education.
“The concern of some investors when entering into an education savings plan is that they will be locked into a very narrow range of allowable education expenditure. Not so for investment bonds.
“With a contemporary education fund it is possible to claim on a broad range of expenses as opposed to just tuition fees. These can include costs such as uniforms, books, materials, private tuition, student fees, residential boarding costs, rent and other accommodation expenses.
“Separate plans do not need to be set up for different needs – instead a single plan can be used to provide a lifetime of education, in a tax advantaged way.
“The investment income of an education fund is taxed up to a maximum rate of 30%. While the earnings accrue within the fund there is no assessable income to declare for either the investor or student. Only when funds are withdrawn will it affect assessable income and may be taxed – and even then the tax may be minimised or even not incurred at all.
“When a claim is made for education expenses from investment earnings, the education fund can obtain a refund of tax on the education expenses being claimed. This produces an education tax benefit which is passed on to the nominated student as part of the education claim and can be worth an additional $30 for every $70 of earnings withdrawn.
“The additional benefit with using an investment bond structure is you can get the best of both worlds; if your child doesn’t go on to tertiary education, you can utilise the money for anything you like.
However, Mr Bird also recommends thorough research, as there are a number of ‘copy-cat’ funds that are not true education funds at all.
“An investment bond education strategy is not a silver bullet that will solve every funding need; basic financial planning principles apply. It is still very much a case of doing the math and crunching the numbers to arrive at the right outcome, using the right strategy, and the right structure.”
* Based on latest available figures from Q3 2014 to Q3 2015: http://www.abs.gov.au/AUSSTATS/abs@.nsf/mf/6401.0?opendocument#from-banner=LN
Lifeplan Funds Management is a specialist business of Australian Unity Investments. It is a market leader in investment and funeral bonds, and a leading provider of education investment funds.
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