An education in saving

The costs of educating children just keep rising. The most expensive schools charge about $25,000 a year and continue to increase their fees by up to 8 per cent a year. This year, some have responded to the tough times and limited their increases to less than inflation, but most haven't. And the figures can be daunting.

Parents who elect to send their child to a private high school face a bill of up to $150,000 for six years. Even public schools are not free. But stumping up education costs does not need to break the bank providing you start a disciplined savings regime early enough.

Which investment options you choose will depend on how long you have before starting to meet those costs. Parents who start a savings plan at the birth of their child will be best off because they are allowing compounding to do its work. And the bigger the initial investment, the better.

But there are strategies for those who need to make up for lost time too. Apart from the time-frame, the other big factor is the level of control parents want.

Education-specific savings plans need the least input from parents. But if they want more control and flexibility they have to be prepared to put in the work needed to manage their investment.

While there are plenty of investment options, most have fees attached, which for managed funds can be as much as 2 per cent a year. And then there is tax.

For many parents, the best product may be the one they already have if they wish to avoid these additional costs and taxes - their mortgage. Making high extra repayments early on and redrawing the money when school fees are needed, might be the simplest, most effective approach.

Australian Scholarships Group

The oldest and best-known plan is that run by not-for-profit Australian Scholarships Group (ASG). Its basic Education Fund helps cover the costs of public secondary and tertiary education. Its Supplementary Education Program helps parents save for private primary, secondary and tertiary costs.

ASG also has an insurance element, which will cover the education costs of members if a family's major income provider dies. The child will receive the full benefit without the family having to make any further contributions. Support is available to keep parents saving, as well as career guidance for students.

Louise Biti, a director of Strategy Steps, which provides technical support to financial planning firms, says ASG is good for parents who need help to make a commitment to a savings plan.

However, parents should be aware that if their child does not go on to further education or training, they will receive back only their contributions and not the earnings.

Parents typically start with the basic Education Fund straight after the child is born with a contribution of $11 a week. The later the fund is started the higher the contribution level, and the child must be enrolled before reaching age 10. Once the child is enrolled in the fund, parents who need to save more can take out the supplementary program and contribute any sum.

If money from the supplementary program is to be accessed to pay for primary school costs the program must be started prior to the child's second birthday, for secondary school before the eighth birthday and for tertiary education or training, before the 10th.

The money is invested in a balanced investment portfolio that, over the long term, after costs and taxes, grows at about 5 per cent a year.

Michelle Hunder, general manager of development at ASG, estimates putting $11 a week into the Education Fund and $15 into the Supplementary Program, starting before the child turns one, will accumulate just over $29,000 for secondary school costs and just under $13,000 for tertiary education or training.

CBA plan

The Commonwealth Bank Education Savings Plan has four investment options. The most conservative option invests in fixed interest and cash and the most aggressive is half invested in global shares and half in Australian shares.

With the crash in global sharemarkets, the returns of the higher-risk options have been poor, although over time these will probably improve. The most conservative option has produced an annual average return of about 5 per cent. The others range from 2 per cent to minus 3 per cent since inception in 2005.

While ASG starts coverage at high school, the CBA plan covers preschool, primary, secondary and a range of tertiary eduction. Under the CBA plan, a maximum contribution of $365,000 is allowed per child. It's a flexible plan in that it can be started at any age. The CBA plan requires a minimum initial contribution of $1000. There is also an optional savings plan that requires a minimum contribution of $100 a month.

Australian Unity

Australian Unity also has an Education Savings Plan but unlike the other plans, this one is designed for post-secondary education and training.

There are three underlying options, each with different risk-versus-return characteristics. The plan can be used for almost any higher education, vocational or career-training course or expense.

The money saved in each of the three plans can used for any purpose but some of the tax advantages will be lost if it is not used for Tax Office-approved education and training purposes.

Investment bonds

The term "bond" is a bit confusing as investment bonds are really just managed funds that differ in the way they are taxed.

Each bond has a range of investment options and is provided by institutions such as Australian Unity, IOOF (WealthBuilder with 12 underlying investment options) and ING (Tax Effective Investment Bond with investment options) among others.

Tax is paid on earnings at 30 per cent. No capital gains tax is paid if the bond is held for at least 10 years. But there are rules on how much can be contributed to the bond, with the maximum being 25 per cent more than the previous year's contribution. But if there is no contribution in any 12-month period, further contributions will re-start the 10-year tax-paid period.

"Investment bonds, the old insurance and friendly society bonds, may prove very effective and I am a proponent of them in appropriate circumstances," says Laura Menschik, a financial planner and director of WLM Financial Services.

Menschik has an investment bond herself, for her grandchildren. The bond does not form part of her estate and, if she dies, is passed on to them.

As long as the investment bond is held for 10 years, the capital can be withdrawn tax-paid and the money can be used for any purpose. Menschik likes the flexibility because the money can be used for education or any other purpose, such as a car.

"I have always felt that with clients, flexibility is the key because you never know," she says.

The other advantage is nothing is required to go in the investor's tax return until the capital is drawn down.

Australian shares

A good way to get immediate diversification is to buy shares in a big, conservatively managed listed investment company (LIC).

The big ones that invest in Australian shares and securities, such as Australian Foundation Investment Company and Argo Investments, cost investors much less than unlisted managed funds, the unit trusts that invest in Australian shares. And their costs can be very low, typically of the order of 0.2 per cent a year for the big LICs investing in Australian shares.

Like all share-based investments, a long investment time-frame and tolerance for risk is needed to ride out the sharemarket's inevitable peaks and troughs. Some LICs have dividend re-investment plans and allow investors to buy additional shares at a discount to the market prices up to twice a year.

Care has to be taken when buying shares in LICs because the share prices can move out of alignment with the value of LIC investment portfolios on a per share basis. In bear markets, the share price tends to trade at a premium to the asset backing as investors switch out of riskier investments into the conservatively managed LICs. That's why advice from a stockbroker is needed before investing in LICs.

Some have dividend re-investment plans and some allow investors to regularly top-up their shares at prices that are discounted to the market price with no brokerage or administrative cost.

Managed funds

Unlisted managed funds, called unit trusts, have an advantage over LICs in that there is a far bigger range of fund managers. As well, there is a far bigger variety of investment markets in which they invest. Each unit in the trust trades at a price equal to the assets in the fund, on a per unit basis. Small amounts of money can be easily added to the investment regularly.

Drawbacks include the much higher costs for investors than for big LICs. Also, some unit trust managers churn their portfolios to maximise the gross return, which can reduce the tax-effectiveness of the funds and increase costs.

An alternative is to invest in a unit trust whose returns match that of the market in which it is investing.

The best-known index manager, Vanguard Investments, charges fees that are about half of that of most unit trust managers, some of which cost up to 2 per cent a year. Tax-effectiveness is high as the index managers only change the portfolio to match changes in the composition of the market index it is matching.

Gearing

AMP financial planner Andrew Heaven from WealthPartners Financial Solutions, says margin lending can work well for parents with good cash flows, who are in secure employment and have a "moderately aggressive" risk profile. He says the minium time-frame for investment is five to seven years. Margin lenders have savings plans where the parents contribute as little as a few hundred dollars a month and the lender lends a matching amount.

Most lenders offer a good spread of Australian listed companies and managed funds in which to invest and interest costs on the borrowings are tax-deductable. With investments in shares or managed funds, income is paid to the investor at least once a year and has to be declared on the investor's tax return. The risk with a gearing strategy is that, just as the returns are magnified on the way up, so they are on the way down and so the loan-to-valuation ratio should be conservative. Heaven says grandparents are using allocated pensions to help fund their grandchildren's education.

"We are seeing a lot of interest where grandparents are drawing their allocated pension tax-free and there's no limit to how much they can take out," he says.

SHARES RECOVERY COULD BE YEARS AWAY

THE global economic downturn is just months old. With the dire economic outlook it could be many months, perhaps several years, before markets recover. No one really knows what will happen but caution is the watchword.

In previous downturns sharemarkets have been known to come back very strongly but the consensus view of economists is that sharemarkets may not recover for at least another 12 months, perhaps even longer.

That means those investing in the sharemarket, whether directly or through a manager or plan, need to invest for at least five years.

"If the time-frame is less than five years, then you should not be substantially in growth assets," says AMP financial planner Andrew Heaven, from WealthPartners Financial Solutions.

Those investing within time-frames of less than five years would be better off in a diversified investment with a high exposure to fixed interest and a smaller exposure to shares, Heaven says.

MORTGAGE REDRAW

"THE most tax-efficient way to pay for anything is to make extra repayments on your home loan and to withdraw it later but it requires an incredible amount of discipline," Louise Biti says.

Most home-buyers are paying interest on their mortgage of about 6 per cent a year. Making additional repayments is equivalent to having an investment return of 6 per cent after tax and costs. Managed investments, education plans and direct shares incur costs of up to 2 per cent a year.

The main hurdle to the redraw strategy is psychological. The loan is being reduced rather than the money being put into a distinct savings plan or investment. Biti says it is "all about identifying it as savings, not just a reduction on the home loan".

However, she says this can be solved by having an offset account tied to the mortgage. With an offset account, the interest that would be paid on the account is deducted from the interest accruing on the mortgage. With regular contributions to the offset account, the account balance grows.

Biti says consumers should check the mortgage offers 100 per cent offset, meaning the interest rate deemed to be paid on the offset matches the mortgage interest rate.

She says people considering this strategy need to check for the fees and charges.

The costs of an offset account, if any, need to be compared with the lender's redraw policy. If the lender has costs on its offset account, the redraw strategy may be better.

Some lenders have a minimum redraw amount and may also charge an administration fee per withdrawal as high as $50. Some of the larger financial lenders allow customers to access their redraw through internet banking, whereas smaller lenders may require borrowers to fax or email transfer forms for approval.

While the best approach is to start a savings plan early, when the child is very young, for those who have missed the boat, using redraw may be a better option. Alternatively, for many parents the only solution may be to take out a bigger mortgage.

Matt Walsh, the general manager of strategy and development for Lifeplan Funds Management, which is the underlying provider of the CBA Education Savings Plan, says mortgage redraw can be a good strategy. However, he says many people who upgrade their family home tend to use all of the credit available to them. The redraw strategy may also come unstuck in the event of divorce and especially where one partner goes on to have a second family.

HOW MUCH TO PUT AWAY

LET'S say that $50,000 needs to be saved by the time the child reaches 12 years of age.

Assuming the saving plan is started when the child is born and the investment return is 7 per cent a year, after taxes and costs, the parents would need to save $223 a month to reach $50,000 in today's dollars.

At a rate of 5 per cent a year, $254 a month would have to be put away to reach $50,000.

Source: Strategy Solutions