Few gifts are as valuable as an education. But if your intention is to pay for the schooling of your grandchildren or great‐grandchildren, you should be aware of the pros and cons of the various options.
One of the most enjoyable aspects of retirement is the fact that you have time to be a part of the life of your grandkids and/or great-grandkids. Passing on knowledge, helping them achieve goals and simply being there when they need you is a highly rewarding experience that is difficult to match. But some retirees wish to take their legacy further by investing in a child’s education. How then do you best go about making this investment? There are many choices, each with its benefits and drawbacks.
Gifting and social security
Gifting may impact your eligibility for social security so you need to be across the rules. Right now you can gift up to $10,000 annually, up to a maximum of $30,000 over five consecutive years, without your pension being affected. However, there are plenty of private schools whose fees will not be covered by such an amount.
Of course, you are able to gift a greater sum, but anything over $10,000 per year or $30,000 every five years will still be counted for five years under the assets test, and deemed for five years under the income test when calculating your social security pension.
Tax implications
If the money is held in the child’s name or held by someone else solely to benefit the child then the income and interest from the fund, in whatever form it might take, is then generally taxable to the child (after the first $416, which is tax-free) and can be taxed at up to 68%. This extremely high tax rate is to dissuade parents and others from sheltering income from their own tax rates by holding assets in their children’s names.
Trusts
A trust is an arrangement where one party (eg a grandparent) holds assets for another party (eg grandchildren). This can include formal arrangements such as a family trust, or informal arrangements where a grandparent legally owns and invests assets solely for the benefit of their grandchildren.
One benefit of a formal trust is that you can create specific instructions as to how it is managed and for what purposes its assets can be used, including specifying the timing of the trust’s outgoings as the grandchildren go through various stages of school and university. The disadvantages include the additional cost to set up and maintain such an arrangement.
An amount saved for education may not justify the formation of a formal trust, but instead you may consider holding funds for the child’s benefit in an informal trust arrangement, where the assets are legally owned in your name or the child’s parents’ names.
The tax treatment of trust income can be complex and will depend on the type of trust and whether the assets are being held solely to benefit the child.
Insurance bonds
Insurance bonds, essentially packaged investment vehicles that are offered by insurance companies, are often invested across a range of managed funds that suit various risk profiles.
Money is usually invested for a 10 year period, meaning some forward planning is required. But after that period any income and capital gain typically does not need to be declared and tax on investment earnings is paid, at a rate of 30%, within the bond by the insurance company.
A lump sum is invested up front and further contributions can be made, but tax penalties can apply where contributions during a year exceed 125% of the previous year’s investment. Depending on your specific situation, you may or may not be able to access the funds tax-free prior to their 10 year maturity.
Education funds
Education funds or Education Savings Plans (ESPs) are similar to insurance bonds but with stricter rules. ESPs are designed
for saving towards tertiary education, as the earnings on investments can be used to pay education expenses of the nominated child. These funds have been granted special tax status by the Federal Government as they encourage education, but the flipside is that they are more restrictive and offer less options and tighter guidelines for use of the funds.
Earnings used for education expenses are taxed as income for the student (income up to $20,542 is usually tax-free for students over 18). However, high tax rates apply to children under 18 where education expenses, along with certain other assessable income of the student, exceeds $416.
Otherwise they follow similar rules to insurance bonds, including an original lump sum, additions each year of no more than 125% of the previous year and a maturity period. But do be careful with the small print.
There are numerous options when giving the gift of education, just be sure that they match your own specific circumstances. If they do, then it could be the greatest gift you will ever give.
Next steps
- Go over your options with us - there is no one-size fits-all approach.
- Discuss the options with the parent of the child. It is ijmportant to ensure your generosity will not create personal or financial (especially tax) issues for them.
- As with any other investment, re-visit it regularly and discuss its performance with us.