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Dear Aussie Advisor: I've just had my first child. Is an education bond a good idea?

Brendan Gow
·Contributor
·5-min read
(Source: Brendan Gow, Getty)
(Source: Brendan Gow, Getty)

Dear Aussie Advisor,

My wife and I have just had our first child. We are trying to put some money aside so we can pay for his schooling when he’s older. With low interest rates on deposits and a reluctance to invest in the share market, we were wondering whether an education bond could help us put aside money for his education? Could you help us understand the risks and benefits of an education bond, including whether there are any tax benefits?

Many thanks,
Todd

Hi Todd,

Firstly, Congratulations to both your wife and yourself on your first child. What an exciting time for you both!

This is a great question, and one that often comes up in conversations around future planning and children. When it comes to planning for their ‘transition into adulthood’, there are a few points to consider.

Year in, year out, education costs continue to outstrip the pace of inflation, and the past 10 years has been no exception. Whilst inflation, as measured by the CPI, clocked in at 21 percent, education costs clocked in at 57 percent.

More from the Aussie Advisor

Parents want choice, flexibility, and an assurance that they won’t be locked into a pre-determined future when looking at options for saving for their children’s education.

However, not all options offer these benefits. When it comes to education planning, it is essential to understand what funding choices are available.

So, let’s consider some solutions.

Here are your options

The simplest and most tax effective strategy is repayment of non-deductible debt, generally being the home mortgage. Effectively, you reduce your personal debt in non-deductible debt, but keep it open and in redraw, so that when it comes time for you to pay your school fee’s, you draw the money from your mortgage.

However, this strategy requires extreme discipline and runs the risk of the funds being withdrawn to pay for lifestyle assets such as cars, renovations and holidays.

Direct investment in the name of the child, but this also has its limitations. In most cases, the tax-free threshold for children’s income is just $416 per year, and they are hit with a penalty tax of up to 66 percent on earnings once that threshold has been breached.

A trust structure may also be considered as a funding mechanism for education costs, with the most common type of trust being discretionary family trusts. A family trust is a vehicle to accumulate investments with the earnings or profits distributed in the most tax-effective way.

However, this may still fall under the confines of the minor’s penalty tax of 66 percent.

Education funds that are classified as Scholarship Plans under Australian tax law have unique tax features not available with other savings and investment products. These funds are based upon an investment bond structure and can be used for a broad range of educational related expenditure at any age or level of education.

With a contemporary education fund, it is possible to claim on a range of expenses such as uniforms, books, materials, private tuition, student fees, residential boarding costs, excursions and accommodation expenses.

The investment income of an education fund is taxed up to a maximum rate of 30 percent. While the earnings accrue within the fund, there is no assessable income to declare for either the investor or student.

Only when funds are withdrawn will it affect assessable income and may be taxed – and even then, the tax may be minimised or, potentially, not incurred at all. When a claim is made for education expenses from investment earnings, the education fund can obtain a refund of tax on the education expenses being 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 earnings withdrawn.

There are limitations depending on the education bond you go for, and how effectively they operate to the same ‘scholarship plan’ rules under the tax assessment act of 1997.

In a nutshell

In summary, the biggest point to consider are the tax benefits you receive from these bonds.

Mostly, they offer fairly run of the mill underlying investment options within them, such as index funds, which will offer in most cases a steady, stable rate of return over the period that the money is invested.

Brendan Gow, an authorised representative (no. 427470) of Shaw and Partners Limited AFSL236048 (the “Aussie Advisor”). This article has been prepared without taking into consideration any investor's financial situations, objectives or needs. Accordingly, before acting on the advice in this article, if any, you should consider its appropriateness to your financial situation, objectives and needs. Every reasonable effort has been made to ensure the information provided is correct, but we cannot make any representation nor warranty as to the accuracy, completeness or currency of that information. To the extent permissible by law, no responsibility for any errors or misstatements is taken, negligent or otherwise. Shaw or its authorised representatives may also receive fees or brokerage from dealing in financial products, see Shaw’s Financial Services Guide for information about the services offered by Shaw available at http://www.shawandpartners.com.au/.

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