Rising school fees - tips and strategies to pay them
With education costs rising by 5.5 per cent in the year to September 2015 and average wage growth at about 2 per cent, the affordability of private schools is a concern for many parents.
Annual tuition costs can be up to $35,000 for the most expensive high schools in Sydney and Melbourne. Fees at many private schools in those cities are between $20,000 and $30,000.
When you add the cost of uniforms, excursions, building levies and extra-curricular study activities it is easy to see how huge amounts of wealth are consumed from the household balance sheet.
Planning ahead promotes effective use of cash flow, reduces costs and allows you to draw on your funds when required.
Before getting into investment selection, families should undertake a strategic planning session to consider the timeframes and amounts involved, as well as tax and other broader financial strategies. Although not having a specific fund set aside for future school fees can be worrying for parents who are focused on education goals, be confident to first focus on the fundamentals and getting the household’s financial position as strong as possible.
For example, holding adequate cash reserves is a must for young families, as is reducing home loans as quickly as possible. Where the interest saved on the home loan is greater than the after-tax return from an investment, continuing to direct surplus funds towards the home loan provides the best financial return.
To pay annual school fees of $35,000 for six years, a capital amount of around $220,000 to $240,000 needs to be accumulated at the start of that six-year period. If a savings programme is starting 10 years out, this will mean putting away between $20,000 and $25,000 each year.
These figures are expressed in today’s dollar terms, assuming moderate returns and that school fees continue to increase at their current rates. This kind of savings programme is an incredibly tough demand for most young families, and explains why it is common for grandparents to invest in their grandchildren’s education.
Ownership and tax considerations
The investment and tax options suitable to investors can vary depending on the time periods involved. If there is only a short period of time to invest until the funds are required, options may be limited to cash or term deposits. With a timeframe of at least seven years, a larger range of investments, including shares, may be considered because of an increased chance of below-average returns smoothing out over time.
Timing also affects what tax planning opportunities may be available. Contributing money to a superannuation fund can be tax-effective, but funds can only be withdrawn on reaching preservation age. Care needs to be taken to ensure that the timing of investment withdrawal matches when funds are required.
Products designed specifically for education savings plans can initially appear attractive, particularly with a 10-year investment timeframe. But it is important to read the fine print because fees can be relatively high and the same or better tax outcomes can be achieved with other arrangements that provide more flexibility.
If one member of the household has a low tax rate and this is expected to remain consistent for the majority of the life of the investment, he or she may be the most appropriate person to own investments. On the flipside, it is generally unattractive to hold investments in the name of a minor (child under 18) as investment income over $417 per annum is taxed at rates between 47 per cent and 68 per cent.
If investments are held in the name of the parent or grandparent as trustee for the minor, the Australian Taxation Office (ATO) will look at who has control of the investments as well as who is using the investment income, to determine the true owner.
Where the parent or grandparent makes all the investment decisions but also uses the income as if it were their own, the ATO considers the parent or grandparent is in fact the true owner and all dividend income and net capital gains will be taxed at their marginal rate. If the parent or grandparent makes all the investment decisions and the income is reinvested or held for the minor, the ATO considers the child is the owner and all dividend income and net capital gains attract minors’ tax rates.
Discretionary (family) trusts can be effective structures but are complex and costly to run, so will only pay off if large sums of money are available to invest. In all cases, getting the tax reporting right is a complex matter and it is wise to consult a qualified accountant.
Assuming a long-term investment horizon is possible, listed investments provide an ideal opportunity to build a portfolio that is flexible and scalable. Investing in individual shares allows a particular company or sector to be targeted, but even investing in individual blue chip shares is associated with higher company-specific risk and volatility.
Achieving diversification across a portfolio of individual shareholdings can be more expensive and time-consuming than other investment options, particularly when the portfolio is in its early stages and may not have achieved critical scale.
Because of the large proportion of family wealth being directed towards the education goal, costs are an important consideration.
Purchasing shares in a Listed Investment Company (LIC) can be a more cost-effective way to invest in a diversified and managed portfolio of investments. A range of LICs are listed on ASX and management costs and performance vary. As a general rule, look for older-style LICs with a low fee structure, trading at a discount compared to their net tangible asset value. The entire LIC market has moved recently and fewer are trading at discounts.
Exchange-traded funds (ETFs) are also a low-cost way to diversify a portfolio. Unlike LICs, which can adapt their internal investment strategy to account for changes in economic conditions, the investment strategy of the ETF is built into the structure of the product. For example, the Vanguard Australian Shares Index ETF (VAS) seeks to track the return of the S&P/ASX 300 Index. Although the underlying exposure to individual companies will shift, the exposure of the ETF will mirror the S&P/ASX 300.
ETF products have evolved from their traditional passive index approach and investors seeking to add return above the market can investigate smart beta-style ETFs. These use rules-based formulas to create a segment within an index. For example, companies with a high-dividend history or that have traded with lower volatility.
Education costs look set to continue to increase into the foreseeable future and with the outlook for economic growth low, planning now on how to cover these costs requires strategic thinking. For parents or grandparents with the financial stability to commit to a long-term investment plan, listed investments offer a flexible option to fund education costs.
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