Using an education fund to save for the cost of shooling

Tony Di Girolamo discusses how using an education fund can help to save for a child’s schooling.

The ever-increasing cost of education in Australia means that more parents and grandparents are looking at ways to save for their children’s, or grandchildren’s, education.

Even for parents who don’t seek a private education for their children, there can be significant add-on costs in the public school system.

Then there’s tertiary education and vocational training, which can mean a graduate taking on significant debt before they start their career.

It is, therefore, becoming common for families to put in place plans that allow them to save for their children’s education.

Often grandparents also want to leave some useful legacy for their family. The biggest question they face is, what is the right approach?

For instance, if grandparents wish to set up a fund for their grandchildren, how can they be sure the money is used for the purpose it is intended?

Education savings plans have been around for many years, but some available today are very different to their predecessors.

They have evolved to take into account the changed investment opportunities and needs of families wishing to set up a nest egg to offset the increasing cost of education.

Legislative changes introduced on January 1, 2003, provided attractive tax benefits for education funds and paved the way for the education funds of today.

Such education funds provide a wide range of portfolio options for investors to choose from, are easy to manage, and are very flexible when it comes to making contributions and withdrawals to pay for education expenses. Generally, there are no penalties for withdrawals, no restrictions on the amount that can be withdrawn and no forfeiture of earnings.

How do they work?

The investment income of an education fund is taxed at a maximum rate of 30 per cent.

This tax is paid by the education fund — not the investor or the student — and while the earnings accrue within the fund there is no assessable income to declare in the annual tax returns of the investor or the student. In addition, the fund’s tax rate may be lower due to tax credits such as franking credits and foreign tax credits from the underlying investments.

When a claim is made for education expenses from policy earnings, the education fund can obtain a refund of tax on the expenses 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 accrued earnings withdrawn (see case study 1).

Education claims, which include the education tax benefit, are treated as assessable investment income earned by the student. The effective tax-free threshold for Australian residents (which includes the low income tax offset) depends on the age of the student.

For the 2009-10 tax year, the effective threshold for under 18s is $3,000; for those over 18 it is $15,000 (see case study 2). Education claims can utilise these thresholds in a highly effective manner, which is a major advantage of this kind of investment.

Withdrawals of investor contributions for reasons other than education are also treated as tax-free refunds of capital to the investor.

Education-related expenses

In the past, some education funds had limits on what expenses were permitted and when the funds could be used.

However, contemporary education funds, which have been appropriately structured, can be used for a broad range of expenditure incurred in relation to primary, secondary and tertiary education and many other approved courses including:

• Education and training courses (both full-time and part-time) provided by universities, postgraduate higher-education providers, public and private colleges, TAFE, and special-purpose programs;
• Education programs for children with physical, intellectual or learning disabilities; and
• Courses for mature age students.

With contemporary education funds, parents (and other contributors) do not need to set up separate plans for different levels of education but can use a single plan to provide a lifetime of education — from preschool through to university and post-graduate studies.

Access to fund benefits, including the education tax benefit, does not depend on the student attaining a particular educational standard.

The types of education expenses that can be claimed are much broader than just tuition fees.

Costs such as uniforms, course-related out-of-school private tuition, books, materials, student fees, residential boarding costs, rent and other accommodation expenses can be paid for out of the education savings plan.

Some education funds provide an allowance for a student living away from home, which allows them to withdraw an education benefit of up to $5,500 per calendar year to meet general living expenses.

As with all investments, investors should make sure they check the guidelines of any fund to ensure they are appropriate for their family.

Student protection and estate planning features

Most education funds also have a range of student protection and estate-planning features, which help to give parents peace of mind should anything happen to them.

For example, they can nominate a ‘plan guardian’ to look after the plan so that their original wishes are carried out in the event of their death or disability.

In the event that the nominated student dies after the initial investor’s own death, they may also be able to pass any remaining plan investment either to nominated beneficiaries, or back to their estate.

Investment options

Portfolio choices can range from the very conservative, such as a cash option, to high-growth portfolios, with a broad choice of single-manager and multi-manager offerings. There are even ‘socially-responsible’ investment options.

Education savings plans can also help advisers build relationships with a younger, wealth-accumulating client base, as this is an investment that holds a high level of attraction for them.

New parents, while perhaps having limited financial resources, still want to be able to offer their children the best education they can afford. Quite often, the difference between parents being able to afford the type of education they would like for their children is not so much about household income but how soon the saving starts and the priority that is placed on education.

Even a relatively modest amount can help relieve the burden in future years.

Investing for education can open up a world of opportunities to attract new and younger clients, as well as better service the needs of older, more established clients. Modern education funds bear little resemblance to those of days gone by, and advisers and investors may be missing opportunities by ignoring this unique offering.

Tony Di Girolamo is head of specialised products at Lifeplan Funds Management.