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Tips to bankroll education fees

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One of the most enduring themes I’ve seen as a financial adviser is the willingness of parents to want to help their kids. Many parents want to prepare for private school education or help with university fees to keep their kids out of debt.

For the term of their natural life!

I recently talked to people who were in their 60s and were afraid that they might die and their kids would have to pay 16.5 per cent tax on the remaining funds in their allocated pension. When I asked how old their kids were, I found that they were 40 and 42 years old! 

Start young

History has told me that the best way to create wealth for your kids in the future, for either education or for any other expenditure reason, is to start as early as possible. It’s ideal that you select a low-cost, but good yielding option and you let compound interest accumulate to deliver the money in the future. 

Work out how much

Financial planners can use their computer programs to work out what you’ll need for your kids given prevailing fees and, given how they rise so regularly, it’s a piece of financial figuring really worth doing. 

Warning!

There are also special funds set up to provide parents with planning and money to cover fees, but I warn parents to do their homework on these businesses. 

The tax is hefty

Another issue is the tax implication of being a good parent, and these have to be considered when constructing an investment plan to bankroll education or anything else for your kids.

Investments or bank accounts in the name of minors with, say parents as trustees, come in for a tough tax treatment. For amounts up to $1445, the first $416 of income is tax free, but the remainder is a whopping 66 per cent! Over $1445, the entire amount is slugged 47 per cent. (By the way, if minors receive income as employees – as owners of a business or from a deceased estate – then normal, not these penalty tax rates, apply. Income from these sources can be put into bank accounts and are taxed normally.) 

Something to think about

Bill Nussbaum, from accountants HLB Mann Judd, says a low-income earning parent might put together a share portfolio with the expressed purpose of using it for education funding. If the shares were fully franked dividends, the low-income parent might be able to earn up to $50,000 and not have a tax bill. 

How would that work?

The tax paid on the shares by the companies can be used to offset tax on the income earned elsewhere.

Fixed interest bank accounts could be looked at for safety but they would require a big early deposit and it might not do the trick of covering school fees as they go up so regularly. 

What are insurance bonds?

Some experts think insurance bonds are an option. They are a 10-year play where an insurance company takes your money, invests it, pays 30 per cent tax and reinvests the proceeds minus its take and the whole thing rolls over. Eventually, the bond is redeemed tax-free.

They’re good because they are locked-away funds, but the returns aren’t flash. Education bonds are based on these products and allow others, such as grandparents, to throw more money in along the way. 

More ideas

Other tricks to save on school fees could be to prepay school fees in advance if the school allows it. Last year the education component of the CPI went up 5.8 per cent while the CPI rose closer to four per cent.

Another smart option is to bump up your home loan repayments to pay off your mortgage really quickly and make sure you have a redraw facility so you can take the money back for the school fees.

For certain tax rates, this play, which is very tax-effective, can be akin to a nine per cent-plus return on an investment. 

Golden oldies

Grandparents could even slip more money into their super through salary sacrifice, knowing they could redraw it after they turn 60, tax-free and when the grandkids are due to start school.

Clearly, I am giving you educated ideas and not advice, because your personal circumstances will determine your best option. Professional advice may be a sensible option. 

Do the maths

Consider this equation in working out what you might need for school fees. Assume you had one child who would go to a private school in high school. Let’s say there will be six years at $10,000 a year meaning you will need $60,000.

Using the rule of 72 and assuming your portfolio of shares or managed investment returns 12 per cent per annum on average, your money doubles every six years.

(Rule of 72 says if you divide your rate of return or interest rate into 72 it shows you how long it takes to double you money!)

So if you put $10,000 into blue chip shares when your baby is born, then by age six the amount should be $20,000 and by age 12, it should be $40,000.

Now, you lose $10,000 a year for six years in fees and keep investing whatever is left, which could you leave you a bit short, but you would do pretty well get there. 

Worth planning

If you do better than 12 per cent, you do it easily but if you don’t, you could be struggling near Year 12 of your child’s schooling.

Clearly the rate of return, the quality of the investments and the stock market’s behaviour will determine whether your plan works.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Thursday, July 14, 2011

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