Parents need to plan well ahead to ease the financial burden of their kids’ education, whether it’s public or private
No matter whether you’re sending your child to an elite private school or the local government school, you’re going to need to dip deep into your pocket.
And for an education likely to span 13 years from kindergarten to Year 12, it’s worth putting plans in place at an early stage to cover the costs.
As Andrew Dunbar, director and senior financial planner at Apt Wealth Partners, points out: “Schooling always costs more than you expect – parents need to plan for much more than tuition fees.”
In fact, the key to managing the cost of education is planning. Tim Howard, technical consultant at BT Advice & Private Wealth, says parents should take a three-pronged approach: “Work out how much you need, how much you can save regularly and where you’re going to put that money.”
Although public schools are at the more affordable end of the spectrum, as I have discovered as a parent of Jack (10) and Harry (8), they’re not altogether free.
Families are asked to pay for uniforms, stationery, textbooks, excursions and digital devices such as laptops or tablets for children to use in the classroom. Some public schools also ask parents to pay a voluntary contribution to help with administration.
At the end of the day, it all adds up. According to the online calculator of education fund provider Australian Scholarships Group (ASG), for a child born in 2017 an education could cost as much as $76,735 for the 13 years from kindergarten to Year 12 in the government school system.
The Catholic system is more financially demanding, with a total K-12 cost of around $229,640.
But even this pales in comparison with the $556,472 it can cost to educate a child in the private (independent) system.
At Melbourne Girls Grammar, for instance, the class of 2018 will pay an annual fee of $35,288 for Year 12. At the King’s School in Sydney, the 2018 annual fee for Year 12 students is $35,697. Boarding costs at many private schools can add another $30,000 annually.
Faced with this sort of expense, parents need to be realistic about which school they can afford.
“Most of the parents we see who are making financial plans for their child’s education are not high income earners,” says Andrew Dunbar.
“They are typically middle-class families worried about how they’ll meet the cost but eager to give their children the opportunity to attend a highly regarded school.
“We crunch the numbers to show parents how much their preferred school is going to cost. Sometimes the figures show it’s just not affordable, and families have to alter their plans.”
That makes selecting a school you can realistically afford an important first step. From here it’s time to knuckle down to decide a choice of investment.
It’s not just the type of investment that matters; it’s also worth considering whose name the investments will be held in.
This determines how much of any returns will be lost to tax and, as we’ll see, some investments offer attractive tax savings.
Our results in Table 1 assume one parent is a homemaker with no employment income and a low personal tax rate – the ideal candidate to be the investment holder.
A big no-no, according to Dunbar, is to save for education through a savings account held in the name of your child.
“There is also a very small window of returns before investment income earned by children is heavily taxed,” he warns.
In addition, returns on savings accounts, for both adults and children, are very low.
That’s a problem because some private school fees are rising by 4%-5% annually, far outpacing inflation of 1.5%.
The only way for your money to keep abreast of rising fees is to opt for growth investments, and this highlights the need for forward planning and saving for education long before your child is due to walk through the school gate.
Also known as insurance bonds, investment bonds are a type of managed investment generally offered by large fund managers. While details like fees and returns may differ, they all operate in much the same way.
The income earned on the bond’s underlying investments is taxed at the company rate of 30%, which is paid by the investment company over the life of the bond if it is held for at least 10 years.
After the 10-year period, earnings are returned to the investor “tax paid”.
This is a plus for parents whose marginal tax rate is above 30% – though bear in mind that a marginal tax rate of 32.5% (plus Medicare) kicks in at an annual income of $37,001, so you don’t need to be a high income earner to benefit from insurance bonds.
It is possible to make additional contributions to insurance bonds. However, these contributions are capped by the 125% rule.
This states that for second and subsequent years of holding the bond, additional contributions must be less than 125% of the previous year’s investment. So if your initial investment is $5000 the maximum that can be contributed in the second year is $6250.
“The 125% rule is reasonably inflexible in terms of how much parents can add to their bond,” says Dunbar.
“The upside is that the money isn’t restricted to meeting the costs of education. The cash can be used for a family holiday or helping your child buy a first car, and that’s a big plus because it’s very difficult to know exactly how a child’s school career will shape up.”
That said, Dunbar notes that the real benefit of insurance bonds comes after 10 years, and this calls for parents to plan. “If you’ve left your run too late or one parent has a marginal tax rate below 30%, these may not be the right choice for you.”
As Table 1 shows, the monthly contribution required to save for a child’s education using insurance bonds can range from $266 for the public system through to $1707 for the private system.
Education bonds, also known as education savings funds or scholarship plans (no resemblance to merit-based scholarships offered by individual schools), are offered by the likes of ASG and Australian Unity.
They work in a similar way to investment bonds. The fund is taxed on its investment earnings at 30% but when money is drawn down to pay for school costs, the fund can claim this 30% tax back – a saving that is passed onto parents.
The downside of these funds is the unknowns.
“Parents don’t know which school will be best suited to their child, or if their youngster will continue on to tertiary education. So it pays to have a flexible savings strategy,” says Dunbar. The trouble is, education bonds can call for parents to lock themselves into an approach that may not allow for life changes.
Some education plans, for instance, only pay parents their own contributions during a child’s secondary school years, with investment returns paid out when a child enters post-secondary education. But not all children will head off to TAFE or university.
Dunbar sums up the situation: “Insurance bonds can be a more flexible investment than education-focused bonds. Insurance bonds offer a greater choice of underlying investment options and the growing number of providers is helping to lower fees.”
Exchange traded funds (ETFs) are typically index-based funds listed on the ASX.
According to Andrew Dunbar, they can have higher one-off costs than unlisted managed funds – each time you buy into an ETF, for instance, you’ll pay brokerage, an expense that can add up over the years spent saving for education. One way around this downside, says Tim Howard, is to “buy reasonable-sized parcels”.
Unlisted funds may not have the downside of brokerage but Dunbar says the distributions can be uncertain and can include capital gains.
“The tax impact will depend on whose name the investment is held in.”
The other drawback of unlisted managed funds, says Dunbar, is the MER (annual management fee), which can be considerably higher than for ETFs.
Table 1 indicates that by using an ETF or unlisted managed fund, parents would need to set aside anywhere from $255 each month for government schooling to $1627 for a private school education.
Still in this vein, another option is a listed investment company (LIC) such as Argo or Australian Foundation Investment Company (AFIC).
“The returns can be more stable than with an unlisted fund, and some LICs have share purchase plans that allow investors to buy up to $15,000 worth of shares with no brokerage, which reduces the one-off costs associated with, say, ETFs,” says Dunbar.
Using your home loan
For many parents, paying school fees often comes at a time when they’re trying to pay down a home loan. So it can make sense to marry the two, using a home loan to help pay for education through the use of an offset account or by making extra repayments and later redrawing cash to pay for school costs.
Andrew Dunbar says there are some upsides to this strategy. “On one hand, parents know exactly the return their money is earning through their home loan rate. However, one of the more challenging aspects is maintaining the discipline over the long term to keep up the extra payments – and not dip into the funds for other purposes.”
A further downside is that home loan rates are very low at present. BT’s Tim Howard says parents need to ask, “Could we do better investing elsewhere?”
Indeed, low-interest rates can make your mortgage a slow way to save for education. As a guide, a family using their home loan to pay for a government school education would need to set aside $274 each month, rising to $1766 for the private system – more than for either insurance bonds or ETFs/unlisted funds.
The complexity of investment returns and tax implications mean professional advice can go a long way when it comes to saving for education. The MoneySmart website can be helpful when you’re shopping around to find an adviser, featuring questions to ask potential advisers to be sure you find an expert you’re comfortable with.