Creating a financial heritage for your children: Part 3

Parents live for the success and happiness of their children. Education isn’t the only answer in ensuring your kids’ future is a bright one, but it is the vital first step. And the earlier you start saving and investing for it, the better. Fortunately, there are loads of ways to build wealth to fund your kids’ education. Read on to find out which option is best for you.

Unit Trusts

Unit trusts offer access to a diverse range of local and offshore assets, and feature varying asset allocation and risk profiles.  What fund you choose will depend on how many years you have until the fees kick in, the anticipated cost of the fees and what level of risk you’re able to take on during the time you're saving up.  

• The earlier you start to invest, the greater the degree of risk you can assume – but bear in mind that you don’t want too much risk associated with what you hopefully consider an essential expense. If you’re able to start from the moment your child is born, you could safely choose a balanced fund with a broad spread across asset classes. These higher equity funds do come with a “medium” level of risk, but they also offer appropriate growth potential for those with a five-year or longer timeframe. 
• There is always the risk that the markets will fall just when you need the fees. This is why, as D-Day looms, you should start gradually moving the funds into lower equity funds which tend to be less volatile.
• If you’re a late starter in investing for education, you’d be better off selecting a lower-risk fund from the start, including money market and bond unit trusts.
• A benefit of unit trusts is that you’re not bound to any contract for investing and the amounts you invest are not restricted. You can contribute additional lump sums without any penalties, and withdraw funds as needed without negative consequences, bar capital gains tax.

As investing in unit trusts is so flexible, they’re best suited to disciplined investors who want a variety of choice of funds and who won’t be tempted to dip into their children’s educational golden nest egg. 

Tax-free savings vehicles/unit trusts

Tax-free saving accounts are an excellent way of investing for education.  The funds are completely free of tax – on the interest or dividends earned, or on the capital gains – as long as your contributions do not exceed R33 000 a year or R500 000 over your lifetime.  

Just like unit trusts, you can make lump-sum or monthly investments, access the funds as you like and leave the money for as long as you like. You can choose from varying asset allocations and risk profiles and there are also no tax implications on withdrawals for education fees. 

Be warned: if you exceed the annual or lifetime limits, you will incur a 40% tax penalty on the excess contributions. Also, withdrawals for education fees are not excluded when your annual and lifetime limits are calculated, meaning that you cannot ‘make up’ the withdrawal amounts. If you have enough money, it makes a lot of sense to open a tax-free savings account in each of your kids’ names and earmark the funds for their education. 

These funds are well suited to parents who are motivated by the additional growth allowed by the tax break and who start early enough to invest up to the R 500 000 limit. 

Life assurance policies

Life assurance companies offer endowment policies which can be used for investing for education. These are contracts in which monthly amounts are invested for a determined period of time with a lump sum paid on maturity.  You have limited access to the funds during the first half of the term and there are also limitations to the increases in contributions to the funds.

These may be suitable for investors who are fond of Ferraris and Fabergé and need a highly structured investment plan. There are also tax benefits for those in high tax brackets as the funds within the endowment are only taxed at 30%.

Payments from your salary

Planning to pay for school fees from your salary can be a risky route. Over the last 10 years, education inflation has been almost 10%, which is 4% above the general inflation rate. So unless your salary increases by at least 10% per year, it will get progressively tougher to accommodate school and university fees in your budget. In the worst case scenario, you may not be earning when your child starts school or university, and you could still be saddled with sizable mortgage repayments. 

This isn’t to say that no one can afford to pay educational fees from their salaries, it’s just that there’s no certainty when it comes to employment, salary increases and business success. Relying on your salary to pay for education may be suited to professional couples where both parties earn salaries in relatively recession-proof industries.  

Debt: avoid it if you can

If you haven’t planned and invested for education, but do highly value it, you could resort to using debt to the fund the cost – the most expensive route of all.  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.  

It’s all very well to want your children to assume the responsibility of the cost of their education and encourage them to take out a student loan, but their debt on graduation does put them at a disadvantage when venturing out into the world of work.  They may feel forced to make employment choices based predominantly on their ability to pay back the money in the short term, as opposed to choices which are more in line with their long-term career plans.

How much to invest

How much to invest per child depends on what school you choose, how long you expect your kids to be at university, and how early you start your educational investment plan.  You can use Prudential’s goal income calculator to help you to determine the amounts you should be investing on an annual basis.  You can consider the ‘Income Required’, as the school or university fee amounts.  Do remember to be realistic about your selected growth above inflation (4% is acceptable for balanced fund allocations) and that education inflation is at least 10%. 

Additional Protection

Even if you have been diligent and have invested for your child’s education from his or her birth, you have the opportunity to further protect and ensure an education by adding an education protector on 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. 

To sum up

Being in a position to choose the school and university that’s best for your child is a privilege – one that is earned through careful planning and investing. The earlier you start the better, as you’ll benefit from compounded growth within unit trusts geared to long-term growth 

Even if you do follow this prudent approach, you may not be able to budget for all educational expenses – not to mention the extra guitar lessons and school hockey trips which also add value to your kids’ lives.  If your budget is limited, it may be best to plan for tertiary expenses which are more focused on setting your child up for a successful career.   

As usual, it’s recommended that you sit down with your financial adviser at least once a year and make changes as your and your children’s educational expectations change.

Prudential has an array of unit trusts and Tax-Free unit trusts geared to short-, medium- and long-term horizons. What you choose depends on time in the market (how early you start), required growth, risk tolerance and expected fees and number of years in schools and universities. We’re committed to assisting our clients to provide for their children’s education.  To find out more, contact your financial adviser or our Client Services Team on 0860 105 775 or at query@prudential.co.za.