Saving for education should be viewed in the same way as saving for your retirement, Old Mutual’s head of financial education, John Manyike, says. It’s a long-term commitment; you wouldn’t start saving for retirement one or two years before you are due to retire.
You need to start saving as early as possible, even if, to begin with, you can afford to put away only a small amount; the important thing is to start, Manyike says.
Jean Minnaar, the general manager of savings solutions at Old Mutual Emerging Markets, agrees that starting early is key. “The later you start saving, the more you will need to save each month, because you will not have benefited from compound interest,” he says.
Gerrit Viljoen, the chief executive of Ultima Financial Planners and a former Financial Planner of the Year, says that even if there are fewer than five or 10 years before your child enters tertiary education, you still have time to save. “Anything you save will help, and reduce the burden on your child when it comes to paying off a student loan.”
When investing for a child’s education, essentially, you have three options: unit trusts, a tax-free savings account (TFSA) or an education policy. All of these are discretionary savings vehicles, which means that the money you invest comes from income that has already been taxed.
1. Unit trust funds
A benefit of unit trusts is that you are not contractually bound to investing for a fixed term. Ideally, however, a unit trust investment should be made over the medium to long term in order for you to benefit fully from compounded growth, Minnaar says.
“Although exposure to market fluctuations means there’s some risk involved, the advantage is that you can access your money at any stage, increase or decrease your contributions, and add lump sums without incurring penalties.”
Unit trusts, bought either directly from an asset manager or through a linked-investment services provider, offer a simple and cost-efficient way to obtain exposure to equities (shares), Craig Sher, the head of research and development at Discovery Invest, says.
“If you have a long-term education saving goal, you want to look at asset classes that have the best chance of out-performing inflation over the long term. Equities have historically proved to be the best option for beating inflation.”
When it comes to choosing a fund, Viljoen says you can’t go wrong with a multi-asset (balanced) fund offered by any of the top asset managers. “All [of these funds] have out-performed the JSE over seven- to 10-year terms, with less risk than general equity funds.” (Multi-asset funds can invest across all the main asset classes of equities, bonds, cash and listed property.) Past returns have been about 14 to 18 percent compounded annually, he says.
Viljoen says it’s less important which fund you choose than it is to start saving and to restrain yourself from jumping in and out of funds, “because that destroys wealth”.
To illustrate his point, Viljoen cites the unit trust fund with the longest track record, the Old Mutual Investor’s Fund, which is 50 years old. “If you had invested R100 a month since October 1966 and maintained it until October 2016, you would have contributed R60 000 to the fund, and your investment would be worth R30 million today.”
Viljoen says although the fund barely delivered a return for five to 10 years, it eventually produced average growth of 16.7 percent over its 50-year history. This, he says, shows the value of putting in the hard yards – “time in the market”.
Index-tracking funds are popular among investors, because they produce returns in line with the market and charge low fees, and the risks are reduced when you have a long investment horizon.
Helena Conradie, the chief executive at Satrix, says you can open the investment in your child’s name. You will have to sign the transaction instruction forms until your child reaches the age of 18. From then on, they can sign all instructions.
If the investment is in your own name, you will be liable to pay the capital gains tax (CGT) at your marginal rate when you sell the units, whereas a child would be likely to pay CGT at a lower rate.
• Warning. If you have a long time horizon (say, 15 years or more), you may be keen on a general equity fund, which invests more aggressively – and, hence, is more risky – than a multi-asset fund. For example, Allan Gray’s Balanced Fund produced an annual average return of 16.12 percent a year over the past 15 years, while its Equity Fund delivered 18.57 percent a year over the same period. (These are the returns after fees.)
The risk of an equity fund is that the market falls soon before you want to disinvest. To mitigate this risk, in the years leading up to the date on which you want to disinvest, you need to start moving your money, gradually, into a low-equity multi-asset fund.
If the growth on the capital has been significant, another reason for gradually phasing out your investment is to save on CGT . You can exploit the annual CGT exclusion by limiting withdrawals so that the capital gain is no more than R40 000 a year.
If you set up the investment in your child’s name, don’t forget the tax implications. Minors (children under the age of 18) are liable for income tax, so if the income (interest income or capital gains) is more than the annual tax-exempt amount, the child must register as a taxpayer and submit a tax return, Conradie says. And if you invest more than the annual donations tax exemption of R100 000 into an investment in your child’s name, you will incur donations tax at a rate of 20 percent of the amount that exceeds R100 000.
With a TFSA, you can make lump-sum or monthly instalments, easily access your funds, stop or restart your payments whenever you like, and leave money invested for as long as you like.
More importantly, your investment (including any growth) is completely free of tax on the interest or dividends earned, or the gains on the capital, as long as your contributions do not exceed R30 000 a year or R500 000 over your lifetime.
You can open a TFSA for each of your children, so a family of four could save up to R120 000 annually, Minnaar says.
Of all of your options, TFSAs are “the best vehicle”, because your money will grow faster in these accounts than in other savings or investment vehicles, Bennie Wessels, a product actuary at Sanlam Personal Finance, says.
“The tax relief on a TFSA further increases the effect of compound interest, or earning investment returns on investment returns. If you have the capacity to make the maximum contribution of R30 000 per tax year, you should make use of that opportunity to optimise your tax benefits,” Wessels says.
• Warning: Ensure your contributions do not exceed the annual or lifetime limits, or you will incur a tax penalty of 40 percent on the excess contributions, Wessels says. Don’t be too quick to make withdrawals, because these are not excluded when your annual and lifetime limits are calculated. For example, if you contribute R60 000 over two years and in year three withdraw R30 000, you cannot “replace” this R30 000; your future contributions will be limited to R440 000.
3. Education saving plans
The education plans offered by most financial services companies and life assurers are typically endowment policies, Sher says.
“With endowment policies, a monthly contribution is made for a specified period and a lump-sum amount is paid out at the end of the period. The minimum investment term is generally five years. For higher-income earners, endowments potentially offer greater tax efficiency, because they are taxed at a flat rate of 30 percent.”
Minnaar says these products are suitable for consumers who prefer a structured savings plan with limited access to their savings. “In the event of death or disability of a parent, many policies offer a benefit to pay the premiums on your behalf for the remaining period,” he says.
• Warning. The 30-percent tax rate on endowments means they are only suitable for investors on a higher marginal tax rate. So, if your marginal tax rate is 41 percent, you may score, the endowment is taxed at 30 percent, but you will not enjoy the annual interest income exemptions. The endowment tax rate also translates into an effective capital gains tax of 10 percent, compared to the maximum rate of 13.33 percent for individuals paying tax at the highest marginal tax rate of 41 percent.
Life cover is critical is you have dependants. But watch out for life products with a savings components, Gerrit Viljoen of Ultima Ginancial Planners says. "It's not viable to have a life policy with a savings component; it's your worst savings vehicle. We recommend a life policy that covers all risks, including provision for education needs of dependants in the event of your death, and a unit trust or exchange traded fund save save for education expenses."