A recent scan of the news reveals the many ways Covid-19 has shaped Aussies’ behaviour. We’re all shopping online a lot more, hand sanitiser is a must-have accessory and we’re far more thankful every time we see our nearest and dearest.
I’ve seen that last factor driving the decisions of some of my clients in recent months. Prohibited from visiting loved ones throughout lockdowns, I’m seeing grandparents not only wanting to make up for lost time in supporting their adult children and their families but also wanting to leave a lasting legacy for their grandchildren, using the savings they accrued through 2020.
It’s not hard to understand why some families would welcome this type of financial help. According to the ABS’ 2015-16 Household Expenditure Survey, the largest increase in household spending was in education, which jumped by 44 per cent in just six years.
And, while private school fees vary across Australia, parents can expect to pay anywhere up to $40,000 a year for a Year 12 student for a private school, not including any boarding fees or additional costs. So, as education costs continue to outstrip the pace of inflation, it’s not too surprising that education-funding products are quickly gaining popularity with forward-thinking families.
Neil*, a grandparent who’s among our clientele at Australian Unity, is assisting his nine grandchildren through an education savings bond. Neil first established the plan 15 years ago, to provide his grandchildren with the same educational opportunities that he, his wife and their children had growing up.
At the birth of each grandchild, Neil contributes an additional $5,000 to the bond, and thereafter pays $250 per child each month until that child reaches high school. At one stage, Neil was paying $2,250 each month, growing the combined excess funds to $350,000 in value before the drawdowns commenced.
That might sound like a huge sum of money for Neil to devote to his grandchildren’s education, but that’s just one of the ways grandparents can put money aside — not all of which require hundreds of thousands of dollars. I’ve broken down several of the common approaches — and their limitations — to try to help grandparents make the best decision for their families.
Buying an education savings bond
Education savings bonds provide a tax-effective, flexible way to save and pay for a broad range of education expenses for all school-aged children. Just like Neil’s approach, the bond is established with an initial contribution of $1,000, and is best serviced through regular payments to grow the capital.
While investment income in the bond is taxed at a maximum rate of 30 per cent, income is only assessable and taxed once the funds are withdrawn. Even then, the education fund can claim a tax refund of $30 for every $70 of earnings withdrawn for a broad range of education expenses allowable under the Australian Taxation Office’s education tax benefit scheme, so tax may be minimised or potentially not incurred at all.
If, for whatever reason, your grandchild doesn’t need the funds for education expenses, you can use the money for anything you like – such as their home deposit or first car. Just be aware these withdrawals don’t qualify for the education tax benefit and will be assessed as investment income, thus incurring the 30 per cent tax rate.
Investing in a child’s name
In days gone by, when the tax system was simpler and more generous, grandparents may have purchased shares in their grandchild’s name. This approach can still be used today — some online brokers allow you to open a broking account for a minor, with you acting as the account’s trustee — but it has become less favourable in recent years due to the tax implications of assigning a child as the beneficiary of any dividends.
Today, in most cases, the tax-free threshold for children’s income is just $416 per year, and they’re hit with a penalty tax rate of 66 per cent on the dollar once earnings rise above that. Despite record low interest rates, even the annual interest accrued by a simple online savings account could breach this threshold, depending on the size of the deposit.
Where a child under 18 does receive investment income (including dividends or savings account interest), parents will be required to lodge a tax return on their behalf, which includes getting a tax file number for the child. Or, if you’re the account trustee, you’ll need to include the dividend income in your own tax return.
Setting up a trust
A trust structure may also be considered as a funding mechanism for education costs, with the most common type of trust being a discretionary family trust. Essentially, a family trust allows people to exercise discretion when distributing funds to members. They’re commonly used to protect assets such as property or business and provide a range of tax benefits.
But keep in mind that if unearned trust distributions to a minor exceed the $416 tax-free threshold in a tax year, income above that amount may still fall under the minor’s penalty tax rate of 66 per cent, requiring the tax return mentioned above.
It’s important to speak with a financial adviser when considering whether to set up a trust. And for most people, setting up a trust for the sole purpose of funding a child’s education is like using a sledgehammer to crack a nut, particularly since setting one up brings with it legal and accountancy costs. There are simpler and less onerous ways to do it.
Using your superannuation fund
You may be able to use your own superannuation balance, granted you’ve reached a preservation age (typically 55 to 60) and have satisfied the conditions of release. This approach would see grandparents make additional super contributions, before drawing down the funds once they’re able to access their super. This approach relies on a window of opportunity — timing is critical! It also requires the personal resolve that you won’t use the funds for another purpose when the time comes to make a distribution.
The superannuation sector also runs under an unrelenting pace of legislative change, which means what works one year may not work the next, so that’s something to keep in mind when making long-term plans regarding super.
Drawing down the home mortgage
Lastly, and one of the most common strategies, is for parents or grandparents to repay their home mortgage above the monthly minimum repayments, with the intention that the additional money can be redrawn for education expenses later. Be warned, however, that this strategy requires extreme discipline! You need to be wary so as not to redraw funds for other expenses for it to be effective.
If you’ve paid off your home, borrowing using your home equity as security may be an option. Like all forms of credit, the decision to borrow must be well-considered with your own financial circumstances, so it’s important to discuss this with a financial adviser.
How to choose
For any grandparent, there’s no one-size-fits-all solution. As always, sound financial principles apply and solutions must be tailored to everyone’s individual circumstances. It’s a case of talking to your financial adviser and crunching the numbers to arrive at the right strategy and structure for your family.
*Neil’s name was changed to protect his privacy.