Question
We have recently had the addition of a baby girl to our family and are keen to send her to a private school when she reaches high school age.
Some time ago, there were special education savings plans available. Are they still available and are they a good way of saving for her education expenses?
Our plan is to set aside an amount each month and any additional amounts received from her grandparents or others.
Answer
Congratulations on the birth of your daughter. The special education savings plans are still available and you can access various providers by googling “tax-paid education plans”.
The biggest advantage is that they offer a simplified way of making regular savings and might be useful for high tax-payers who don’t have the discipline to set aside a regular amount.
These plans operate under a section of the Tax Act that deals with life insurance and friendly societies which were prevalent in the last century. In essence, they are a tax-paid investment fund operating a little like superannuation, but without the access restrictions.
The funds pay 30 per cent tax on earnings which may be lower than your personal tax rate. Provided the fund operates for 10 years or more, withdrawals from the fund are generally tax free. If you access it before the 10 years are up, all or some of the growth becomes taxable income, but it comes with a 30 per cent tax offset to reduce the tax payable.
Unlike share dividend franking credits, if you don’t use the offset it is not refunded.
You can contribute as much as you like but you can only increase contributions by 25 per cent of the previous year’s contribution. For example, if you contributed $1000 in year one, you could contribute $1250 in year two. If you missed year three, you couldn’t add any more to the fund without the clock resetting.
Modern education funds offer a similar range of investments to a super fund so you can dial up the risk-return mix to your liking.
The other consideration is that these funds can be quite expensive. An alternate approach might be to set up an account with an online share broker and access exchange-traded funds. The fees are significantly less, you have the same flexibility with contributions and withdrawals and some brokers allow you to set up a regular investment plan.
The issue here is that tax may be payable when you sell units in the ETF to fund you daughter’s education.
While boring, the most tax effective and efficient way is to use these extra funds to reduce your mortgage. Particularly as rates rise, the interest payments saved are effectively tax-free earnings. You then re-draw the money when it is needed.
On a risk-return trade-off, this is the safest strategy.
Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association