If you approach a financial advisor or broker to ask about education savings, chances are that you will be offered a specially packaged endowment policy or a unit trust. There are pros and cons to both types of education savings product. We had a discussion with savings experts, Here’s what they had to say:
What is an endowment policy?Ricky Rohrbeck, an independent financial advisor, explains that an endowment policy is an investment policy that pays out after a fixed term. The growth is not guaranteed, but endowment policies are a fairly safe investment vehicle. You can purchase a guarantee on your capital, but this will in all likelihood decrease your growth prospects.
The growth on endowment policies is also taxed at a standard rate of 30%, while the growth on other investments is taxed at your income tax rate (the percentage of your monthly income that you pay in income tax). This means that if your income tax rate is higher than 30%, you will get a better rate on the tax on your endowment policy than you would on any other type of investment.
Pros: Endowment policies have a set pay-out date and penalties for withdrawing too early, which will hopefully deter you from dipping into the policy when you need cash and if your marginal tax rate is higher than 30%, these policies are a good tax-planning tool.
Cons: Endowment policies are usually expensive, with fees usually at the higher end of the 3% to 5% range, which means that you need to earn significant returns just to beat inflation. And if your marginal tax rate is lower than 30%, you will be paying more tax on the interest you earn than on any other investment.
As an alternative, consider unit trusts Rohrbeck says that as an alternative to endowment policies, you should also consider the benefits offered by unit trusts. With unit trusts, you are buying a unit in a basket of shares managed by a fund manager. The fees fall within the same 3% to 5% range as endowment policies, but they usually fall at the lower end of that range – and the percentage you are charged in fees decreases the more you invest.
The growth in unit trusts is usually taxed at your income tax rate, but you do get an exemption on the first R23 800 of interest earned.
Pros: Unit trusts are flexible, so you can withdraw your money at any time, the fees are generally lower than on endowment policies, and you can potentially negotiate on these with your broker, which means that you will probably earn higher returns. Don’t forget that the first R23 800 of interested earned is tax free.
Cons: The pro listed above – that you can withdraw at any time – is also a con. Without a forced saving, you might find that you cash out your unit trusts for purposes other than education.
How do I decide?When making the decision about which type of product to buy, Rohrbeck says it is important that you look at the whole picture:
- Consider that the current inflation rate is 6% to 7% and bear in mind that you have to beat that to be realising any kind of real growth on your investment.
- While neither unit trusts nor endowment policies offer guaranteed returns, most brokers will be able to tell you what the anticipated returns should be, so you can compare their growth potential.
- Discuss the fees with your broker and ask whether they are in any way negotiable.
- Finally, consider how you will be taxed on the interest you earn.
These figures and percentages should give you a clearer picture of the costs and returns associated with the investment products you are considering.
Other potential educational savings productsAlthough unit trusts and endowment policies are by far the most commonly used education savings plans, there are other options as well. Stuart Kantor, the CEO of Kanan Wealth, says that there are two government products that offer families good returns on education savings:
- Families that earn less than 180 000 a year can save through Fundisa, the government education savings incentive that offers an annual bonus of up to 25% of your savings, but with a maximum of R600 per year. This means that if you save R200 a month over 12 months – a total of R2 400 – you will receive a bonus of R600 towards your child’s education.
- It is also possible to purchase SA Retail Bonds from a Treasury or your local Pick n Pay. This is a government investment product that guarantees returns over certain terms of investment. There are two types of retail bonds – the first simply guarantees growth, starting at 8.75% over two years. The other guarantees growth above inflation, starting at inflation plus 3.35% over three years.
- Another fantastic savings vehicle is a tax-free savings account, which is an investment product now offered by most banks and financial services providers. These are specially created unit trusts that offer the benefit that you will not be taxed at all on the growth that your investments earn. You are limited to investing R30 000 per year and R500 000 in your lifetime, but you can increase these limits by investing in your children’s names for their future. Should you do this, it will of course mean that you will be eating into their lifetime investment limit, before they are old enough to invest for themselves.
How can I get the most out of my education savings? Kantor says that it’s important to remember that education is expensive, so it’s a good idea to get started as early as possible and save as much as possible.
At a minimum, you should aim to have saved up one year of your child’s school fees before they start school so that you can pay upfront for the year and benefit from the discount that almost all schools offer for early payment. Then, instead of paying your fees monthly, you spend the year paying into a new investment product so that you are always one year ahead of the game.
Obviously, there is no upper limit to what you can save for education or your child’s future – and some parents fund schooling out of their monthly income while saving for university or res fees for their children along the way.
Whatever approach you take, and however much you can afford to save, the effort is worth the outcome of securing the best possible future for your child.