Saving for your children's education

Tuesday, April 18, 2006
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Amp,Commonwealth Bank Of Australia.,Macquarie

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From Money Magazine

Educating your children is a major expense — the sooner you start saving for it the better. Susan Hely explains how to go about it.

Parents like Stephen and Desma Jones say private schools are worth it. Sure, the financial burden is heavy, but Stephen says he values the quality of the teaching, the strong social network that will last his two children Stefanie, 18, and Andrew, 14, a lifetime, and the multicultural student population that has helped them become more worldly.

Many parents nevertheless go faint when they see the cost of school and university fees — just how much depends on the schools and universities they choose. According to a report by the National Centre for Social and Economic Modelling for AMP, Australian parents spend, on average, $50,000 on education and childcare for each child.

Many parents pay school fees, as with most household bills, on an ad hoc basis when they arrive in the mail. About half of all parents use their general savings to pay school fees, according to a survey by Newspoll for the Commonwealth Bank. Of the other half, around a third use savings from a special education saving account, 28 percent tap income from specific investments, while 21 percent take a part-time job to pay the fees and 14 percent use a personal loan or draw down on their flexible mortgage to meet the cost.

Only 40 percent of parents and grandparents are saving for education in advance but almost all admit that their savings fall short, with half of the savers putting aside less than $100 a month or $1200 a year.

Having the money available when children start school is a better option than borrowing to pay school fees. Paying interest on the borrowings can sometimes double the amount you would pay if you had saved the money.

To work out how much you need for your child's education, visit the AMP's cost of education calculator at www.amp.com.au. Also expect private school fees to go up as schools spend more on technology and building projects. Over the past 15 years, school fees have increased at two-and-a-half times the inflation rate. You will find that even a government school has significant costs, from uniforms, excursions and sporting equipment to textbooks, travel expenses and music lessons. The key to funding your child's education is to start early and save regularly. But there is a catch to saving for your children. It is not as straightforward as opening an account and contributing regular savings. For a start there are steep tax rates on children's investment earnings.

High taxes were introduced to discourage parents from splitting their income and diverting it to their children's accounts in order to avoid paying tax on their earnings. So a high tax rate regime applies to income other than "excepted" income, allowed by the tax office.

If a minor has income from employment, for example, it is regarded as excepted income. But if they simply have income from family trust distributions, that income is taxed at special higher rates.

But if you put the investment in the child's name and the income creeps over the tax-free limit, the earnings will be slugged with the high tax rate. The other problem with putting the investment in the child's name is that if you intend the investment to be used to fund a tertiary education, once the child turns 18 they might have a different idea and spend it on an overseas trip or new car.

Most parents or grandparents are better off holding their children's or grandchildren's investment in their name in trust. If the parent or grandparent holds the investments in their own name in trust, they will incur tax at their own marginal tax rate.

So if the parent or grandparent has a spouse on a lower marginal tax bracket, it is best that they become the trustee for the child's savings. And when declaring the income, they may be able to use the franking credits from the education investment to offset tax from their other income. There are a number of different ways to save for education that include specific education saving plans and managed funds. Using your flexible mortgage and paying off the mortgage when you have the cash and then drawing from it to pay the school fees has benefits too.

Education saving plans
A tax-effective way to save that encourages the discipline of regular saving and not spending. The downside is that education saving plans have relatively high fees, particularly for conservative investment options. Also, you must find out what happens to your investment earnings if you withdraw your investment early. Some plans will not pay you any gains.

Education saving plans offer a rare tax advantage. The government does not like to give tax concessions unless it is going to encourage people to save for retirement through superannuation or a child's education through an education saving plan.

Two friendly societies that the tax office allows to rebate all the tax paid on investment earnings at the maturity of the "scholarship plan" are Lifeplan and the Australian Scholarship Group (ASG). The tax benefits vary from plan to plan and are complicated.

Five years ago, education saving plans were inflexible investments that tended to lock people in. This can be a rude shock for some families who need to withdraw their savings earlier for emergencies.

Many of the ASG's investors still belong to the older-style tertiary plans that will only pay out the original contributions — and no investment income — if the child does not attend university or an approved TAFE.

The fees for ASG's education plans vary. James says that ASG keeps fees low and offers many free services to parents, such as vocational guidance and educational material.

Managed funds
If you like regular saving plans, why not try other plans with lower fees? Exchange Traded Funds are listed index funds with fees around 0.28 percent, or Vanguard's diversified balanced funds charge a fee of 0.9 percent. After all, they invest in similar sorts of investments to education plans.

If you choose a diversified fund with investments in fixed interest, cash, property and shares, you can spread your risk and take advantage of long-term growth investments such as property and shares.

Most managed funds do not allow investments to be held in a child's name, but generally they will accept applications if an adult acts as trustee for the child and the trustee provides their own tax file number. Direct shares are also attractive investments for children but, again, the investment may need to be held in the name of a trustee.

Biti is enthusiastic about using flexible mortgages with a redraw facility to meet education bills. "You are going to save paying seven percent interest on your money and there are no fees. It is tax free," she explains.

The downside of drawing down off your mortgage is that most people love to see their home loan balance going down, rather than up. "They have to accept that the balance is going to go up," says Biti. She suggests you keep records on how much you have spent on education and also how much you have saved.

Prepay your school fees
Some private schools allow you to pre-pay your school fees up to 10 years in advance, through a plan from Macquarie Bank. With school fees typically increasing at seven percent per annum over the past 15 years, the ability to save money by prepaying fees a number of years ahead becomes significant.

It works like this: the schools allow you to earn a credit against future tuition fees for early payment of fees. And the credits are not assessable for tax purposes as they meet the tax determinations of the plan. You are told how much the credits will save when you make contributions.

You can make regular payments or one-off payments. If you leave the school the contributions are refundable.

Schools find the prepayment option attractive because it can reduce the risk of bad debts and bring their cash flow forward. Check with your school to find out if pre-paying is an option.

For the complete story see Money Magazine's April 2006 issue. Subscribe now.

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