Are education bonds right for you?
Q. We want to save for the cost of our child’s education and have heard about education bonds.
Is an education bond worth considering?
Education bonds can be a tax-effective way to save and invest for a child’s education, which can often cost more than we expect. In addition to tuition fees, they can also help cover the cost of courses, textbooks, tutors, uniforms, accommodation, equipment, and travel. You can also use them to fund an adult’s (including your own) education.
Education bonds are essentially investment-linked life insurance contracts and they work in a similar way to traditional investment (or insurance) bonds. Think of them as sharing features of both managed funds where your money is pooled with other investors, and an insurance policy, since it has a life insured and a nominated beneficiary. Both types of bonds have similar tax treatment (for example, the 10-year rule and 125% rule), however, education bonds have some extra withdrawal flexibility, tax benefits and estate planning features that investment bonds generally do not offer.
Contributions and capital withdrawals
An education bond consists of two components; the capital component (your contributions) and the earnings component (investment growth).
Similar to investment bonds, education bonds typically offer the choice of making lump sum contributions, and/or regular monthly contributions. Usually, anyone can pay into the bond, including grandparents, relatives and friends, as long as they are over age 16. There is generally no cap on the initial contribution, however, there may be a minimum initial contribution required by the bond issuer.
Where education bonds differ from investment bonds, is that you have the ability to make capital-only withdrawals from your contributions account, instead of having the usual investment bond tax rules apply. Capital-only funds can be accessed tax-free at any time, and for any purpose.
Low-tax investment earnings and a unique education tax benefit
Similar to an investment bond, an education bond is a ‘tax-paid’ investment. The provider pays the tax on investment earnings (up to a maximum of 30%), and you generally don’t need to include earnings in your tax return, unless you withdraw them within 10 years of the first contribution. The net earnings are automatically reinvested within the bond to benefit from compounding and you can usually withdraw the bond tax-free once it’s held for 10 years.
The extra tax benefit of an education bond over an investment bond comes when you withdraw money from the earnings account to cover education costs. Since the provider can claim a tax deduction, the student may receive up to $30 of ‘education tax benefit’ for every $70 withdrawn from the investment earnings account to cover their education costs.
Keep in mind that the student will need to declare any investment earnings and education tax benefit paid to them as taxable income. If under age 18, only the first $416 each year is tax-free, so it can be more tax effective to defer the drawdown of education costs until they are over 18.
Additional estate planning benefits
Like investment bonds, education bonds can provide a means to pass on your wealth in a tax-effective way. Depending on the bond you choose, you may have the option of choosing just one beneficiary or several.
Both investment and education bonds offer ‘Will-like’ nomination features whereby you can nominate and allocate a percentage of the bond benefits to be distributed upon your death. Once you pass away, the bond can be paid out to your nominated beneficiaries tax-free. An added plus of an education bond, is the option to appoint a Bond Guardian to act on your behalf should you die or become incapacitated. Doing this can provide some reassurance that your future wishes will be followed, when your state of health declines.
If your bond matures due to the bond term ending, then the full balance is distributed to you, tax-free provided the bond has been held more than 10 years since the first contribution.
Things to bear in mind
As always, it’s important to consider the potential downsides of any financial decision you make. If you are thinking about investing in an education bond, there a few important things to bear in mind:
- An education bond is generally a long-term investment strategy, and the value of the bond benefits will increase or decrease depending on the investment option you have chosen.
- The future education needs of your children (or grandchildren) are not certain. For example, a child may or may not go on to tertiary education. Some education bonds, for example, may have less flexibility around when you can contribute and when investment returns are paid out.
- While you can withdraw investment earnings from an education bond at any time, and for any purpose, withdrawals that are not education-related will lose the unique education bond tax advantages and investment bond tax rules will apply. Unless you have held the bond for 10 years since the initial contribution, you will need to include details in your tax return and possibly pay income tax
- There may be a number of fees associated with any education bond you choose, including establishment, contribution, management, switching and / or withdrawal fees. It’s crucial to do your research to make sure you fully understand what you’ll be charged.
It’s important to note that the information provided above is general in nature. As such, when making a decision in relation to the appropriateness of an education bond, please consider your own objectives, financial situation and needs.
Contact Carrick Aland’s award-winning Wealth Planning team on 1300 466 998 or visit carrickaland.com.au/wealth-planning/ for specific advice.
This report is prepared by Bridges Financial Services Pty Limited ABN 60 003 474 977 AFSL 240837 (Bridges). Bridges is an ASX Market Participant and part of the IOOF group of companies. This report is prepared by the IOOF Research team for: Bridges Financial Services Pty Limited ABN 60 003 474 977 AFSL 240837, Consultum Financial Advisers Pty Ltd ABN 65 006 373 995 AFSL 230323, Elders Financial Planning ABN 48 007 997 186 AFSL 224645, Financial Services Partners ABN 15 089 512 587 AFSL 237 590, Millennium3 Financial Services Pty Ltd ABN 61 094 529 987 AFSL 244252, RI Advice Group Pty Ltd ABN 23 001 774 125 AFSL 238429, Shadforth Financial Group Ltd ABN 27 127 508 472 AFSL 318613 (‘Advice Licensees’). The Advice Licensees are part of the IOOF group comprising IOOF Holdings ABN 49 100 103 722 and its related bodies corporate (IOOF group). The Advice Licensees and/or their associated entities, directors and/or employees may have a material interest in, and may earn brokerage from, any securities or other financial products referred to in this document or may provide services to the company referred to in this report. The document is not available for distribution outside Australia and may not be passed on to any third person without the prior written consent of the Advice Licensees. The Advice Licensees and associated persons (including persons from whom information in this report is sourced) may do business or seek to do business with companies covered in its research reports. As a result, investors should be aware that the firms or other such persons may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as a single factor in making an investment decision. The document is current as at the date of issue but may be superseded by future publications. You can confirm the currency of this document by checking the intranet site (links below). The information contained in this report is for the sole use of advisers and clients of AFSL entities authorised by the Advice Licensees. This report may be used on the express condition that you have obtained a copy of the Advice Licensees Financial Services Guide (FSG) from their respective website. Disclaimer: The information in this report is general advice only and does not take into account the financial circumstances, needs and objectives of any particular investor. Before acting on the advice contained in this document, you should assess your own circumstances or seek advice from a financial adviser. Where applicable, you should obtain and consider a copy of the Product Disclosure Statement, prospectus or other disclosure material relevant to the financial product before making a decision to acquire a financial product. It is important to note that investments may go up and down and past performance is not an indicator of future performance. The contents of this report should not be disclosed, in whole or in part, to any other party without the prior consent of the IOOF Research Team and Advice Licensees. To the extent permitted by the law, the IOOF Research team and Advice Licensees and their associated entities are not liable for any loss or damage arising from, or in relation to, the contents of this report. For information regarding any potential conflicts of interest and analyst holdings; IOOF Research Team’s coverage criteria, methodology and spread of ratings; and summary information about the qualifications and experience of the IOOF Research Team please visit https://www.ioof.com.au/adviser/investment_funds/ioof_advice_research_process.
