What are some options for saving for my child’s education?

With education fees costing hundreds of thousands of dollars over the school and university years, it’s no wonder people start saving early – but it can be a challenge to ensure that this major investment is both tax-effective and flexible enough for your needs.

The most suitable option will depend on a range of factors such as your tax position, the child’s situation and how and when you need to access the investment. What seems like a straightforward decision can often be complex so it’s worthwhile seeking advice.

Generally, investing in a child’s name is the least tax-effective method of saving as a minor’s unearned income incurs penalty tax of up to 66%. So, most parents opt to invest in their own name.

While managed funds, shares and property can all be good assets for long-term investing, the tax incurred on the income and eventual capital gain from those investments can be a problem, especially if the parents are on high marginal tax rates. In this case, investments may be more tax-effective if held in a trust – but this will also depend on the tax rates of the beneficiaries of the trust.

Some people also consider ‘education scholarship’ plans which lock your money away for a certain number of years, usually until the child reaches high school. While these schemes offer tax benefits, they can only be used to fund education and can’t be accessed for other activities.

Another option is insurance bonds, which can provide similar tax advantages to scholarship plans but with added flexibility.

How do insurance bonds work?

Insurance bonds are essentially packaged investment products offered by insurance firms, which can be particulary useful for long-term investments such as children’s education costs. The bonds are usually invested in a range of managed funds, offering investors a range of investment options to suit different risk profiles and preferences. Once you make an initial investment, your money is invested for your specified purpose until a maturity date, usually ten years away.

What makes them tax-effective?

As an individual, you will not need to declare income or capital gains on your tax return if you hold the investment for ten years or more. Any tax on the investment earnings and realised capital gains are paid within the bond by the insurance company at the company tax rate of 30% (which can be even lower if dividend imputation credits are available).

This feature of investment bonds makes them a highly attractive savings vehicle for long-term purposes such as education, particularly for those on higher marginal tax rates.

Once your investment reaches maturity and you redeem it, you will have no liability for income tax or capital gains tax on that redemption.

Can I add to my bond investment over the years?

Yes, you can make extra contributions to your investment each year, but these must not exceed 125% of contributions made the previous year. So if you invested $10,000 one year, you could only invest up to $12,500 the following year. If you exceed the 125% limit, the 10-year period until maturity will restart.

Can I access the money if I change my mind?

Yes. Unlike some education scholarship schemes which can be inflexible, you can generally withdraw some or all of your bond investment before its maturity date. This applies even if you don’t use the money for the same purpose as what you originally intended.

However, if you do withdraw before maturity (usually ten years), you will be personally required to include the growth component as part of your assessable income for taxation purposes. This is somewhat reduced by a 30% tax offset on these types of withdrawals, which means that retirees and other low income earners may be able to access their funds tax-free.

Can I use insurance bonds to invest for purposes other than education?

Yes, insurance bonds are not limited to saving for educational purposes. Unlike scholarship schemes, you can use them for whatever your desired purpose. Insurance firms offer a number of bonds with varying features to suit different investment purposes. In some cases, they can even be a tax-effective estate planning tool to provide tax-free distributions to beneficiaries, and to help fund aged care costs. You can also use insurance bonds as a tax-effective alternative to super to top-up your long term savings.