“An investment in knowledge pays the best interest.” (Benjamin Franklin)
Investing for your children’s education is one of the great non-negotiables as it provides the foundation for a bright future. As always, however, there’s more than one way to skin this cat.
Should you opt for a tax-free savings account or an endowment fund? And do you need an education protector? Let us unpack the pros and cons of the various investment options to make your decision a little simpler.
Watch it grow in a tax-free savings account
Although tax-free accounts are structured primarily for retirement, they are also an excellent way of investing for education. The growth within the funds is tax-free if your contributions do not exceed R36,000 a year or R500,000 over a lifetime. You can access the funds when you need them and there are no tax implications on withdrawal amounts.
The underlying funds in a tax-free account can include investments from a diverse range of asset classes including local and offshore equity, bonds, property and money market instruments. You’re able to choose the funds based on the amount of time you have until the fees kick in, how much you need to save, and the amount of risk you’re willing to bear to make the education a reality.
The earlier you start to invest, the greater the degree of risk you can assume (counter-intuitive, we know). But do bear in mind that you don’t want too much risk associated with what is a priority expense. There is always the chance that the markets will dip just when you need to pay fees, which is why you should start gradually moving the funds into less volatile funds in the last couple of years before the fees kick in. If you’re a late starter, you’ll be better off selecting lower risk funds from the outset.
Remember that if you contribute more than R36,000 per year, the taxman will take a 40% cut on the excess amount. Also, if you withdraw funds, you cannot ‘make them up again’. Withdrawals eat into your lifetime allowance of R500,000.
You can take further advantage of the tax break by opening up accounts in each of your children’s names, using the R100,000 (per spouse) annual donations tax exemption.
The greatest advantages of using tax-free savings accounts is the additional growth facilitated by the tax break and the variety of choice in the underlying funds. The obvious disadvantage is that using the investment for education could negatively impact your retirement plan. Tax-free accounts are great for parents who are disciplined and won’t dip into the funds for purposes other than their children’s education.
Wrap it up in an endowment fund
Endowment wrappers can also be great for investing for education. They are policy contracts which commit you to contributions for a minimum investment period of 5 years. Once the period expires, proceeds are tax free. As the name suggests, they provide a “wrapper” around various funds of your choice, which – much like tax-free investments – may be invested in various asset classes. The returns are taxed inside the endowment at a flat rate of 30%.
One of the pros of using endowment wrappers for education is that the penalties for withdrawing too early should deter you from dipping into the funds. The 30% flat tax rate is also of benefit to high income earners. A disadvantage is that the administration fees can be higher than those levied on unit trusts, for example, which can put pressure on the performance of the fund. Endowment wrappers often work for investors who tend towards recklessness and need a structured and controlled investment plan.
Some people regard education debt as good debt, putting it in the same category as their home loan. Relying on debt is very risky as you may not be able to secure it when needed and it’s very expensive. Just as compound interest works in your favour when you invest, the cost of interest on debt works very hard against you when you borrow funds over many years.
Some people encourage their children to take out student loans and bear the responsibility for their own education. This does put them at a significant disadvantage when they graduate as they may be forced to take on a job they don’t really want, or it may take them a while to find a job. Debt waits for no one, remember.
An extra layer of protection
Even if you have been diligent and have invested for your child’s education from birth, you can further protect and ensure their education by adding an education protector to your life assurance policy. These typically cover the cost of school and university fees should you pass away prematurely or become critically ill or disabled and unable to work.
Expect the unexpected
Many people don’t save for education because they bank on having a successful career/business and being able to pay for education from their salary or profits. There’s nothing wrong with being optimistic, but life seldom goes quite as planned – especially in today’s world where job security is a thing of the past and the rising cost of education continues to outstrip inflation.
Even if things do go according to plan, investing for education is never a bad idea, especially if you start when your child is born. Speak to a financial adviser to help you to decide how much to invest and where to put it.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.