Opening an education fund for the grandkids

There’s no doubt that education is a lot more expensive now than it used to be and costs are going up. Most children will be at school for 13 years, with many continuing on to tertiary or vocational education.  

Setting up an education fund for the grandkids is one way you can help them reach their full potential, but before you do, here’s what you need to know.  

According to the Good Schools Guide, it currently costs each year for each child approximately $4,455 to attend a metropolitan secondary government school, $12,599 to attend a Catholic school and $22,450 to attend an independent school.  

A university bachelor’s degree can currently cost between $20,000 to $45,000, with living costs upwards of $21,000 per year if the student is living out of home. While there are government loans available to cover university tuition fees, these costs will only continue to rise. 

Planning ahead can help financially support your grandkids while they learn, allowing them to focus on their studies.  

There’s a lot of different investment options to consider when setting up an education fund. Many allow you to grow your investment through simple or compound interest. So, what is the difference between them?

Compound interest  

With many savings accounts, you earn interest each month on your principal (the amount you deposited into the account). That interest will be added to your account, increasing your balance and subsequently increasing the amount of interest you earn since your balance has grown (even if you don’t add any more to it). This is known as compound interest. The longer you save, the more interest you will earn.  

The federal government’s Moneysmart website provides this example – if you put $10,000 into a savings account with 3% interest compounded monthly (with no additional deposits): 

• After five years, you'd have $11,616. You'd earn $1,616 in interest. 
• After 10 years you'd have $13,494. You'd earn $3,494 in interest. 
• After 20 years you'd have $18,208. You'd earn $8,208 in interest. 

Since compound interest benefits you more the longer you save, getting started with an education fund sooner can allow you and your grandchild to benefit more. 

Simple interest

In contrast, simple interest will just pay you interest on your principal at the end of a predetermined period (no interest earned on your interest). This is most common with term deposit accounts which pay interest upon maturity. You can however reinvest that interest in a new term deposit if you choose, which will allow you to benefit from compounding.  

So how exactly do you set up an education fund? There are a few different investment options you can consider, each with their own benefits and implications. Here are some of the common options.  

A high interest savings account is a bank account that usually pays a higher rate of interest on your savings than other transaction accounts. They sometimes have minimum deposit requirements to open an account and can include bonus interest rates if certain conditions are met (such as depositing a minimum amount or not making withdrawals).  

This type of account enables you to add or withdraw money at any time, plus benefit from compound interest as interest is usually paid to the account monthly. 

Savings accounts typically have a variable interest rate, so there is some risk of interest rates being lowered by your financial institution, which will reduce the interest earned. However, it also means when they go up, so too does the interest you earn.  

Interest earned is subject to tax regardless of whether the account is in your name or your grandchild’s name.  

A term deposit account is a type of savings account which offers a fixed interest rate for a set period of time (this can be between one month and five years). Your savings will be locked away for the term you select and you can’t add or remove funds in that time without financial penalty.  

This is a good option to lock away money and still earn interest if you’re worried about you or your grandchild spending it. As funds can’t be added or withdrawn during the term, this can remove temptation.  

Term deposits earn simple interest, which is usually paid at the end of the term but you can choose to earn interest monthly. Just bear in mind that this can’t be added to the term deposit during the term.

While you can’t benefit from compound interest during your term, term deposits do offer a guaranteed return and your interest rate is protected during your term period. This type of account usually have no fees associated, and can help teach the grandchild about savings while also keeping them from spending the money.  

Like high interest savings accounts, interest earned is subject to tax regardless of whether the account is in your name or your grandchild’s name.  

A share is a portion of company ownership that can be bought and sold through trading platforms. Share prices fluctuate depending on the market, which can mean a lot of growth or a lot of decline in share value depending on what is happening with the company, industry, or even national or global trade at the time.  

While not an education ‘fund’ as such, shares have historically been one of the highest performing investment options over the long term (although it should be noted that past performance is not a guarantee of future performance). Vanguard found investments of $10,000 in Australian shares over the last 30 years achieved 9.8 per cent return per annum on average, which outperforms the 4.4 per cent per annum average return from cash over that same period.  

There are two ways to make money from shares – earning dividends (profits shared among shareholders, which not all companies offer) or by selling the shares for a capital gain.  

You could choose to gift the shares to your grandchild or sell the shares and give them the proceeds. Either way, there are capital gains and loss tax implications with gifting or selling shares that must be taken into account. If you own shares for more than 12 months, you may qualify for a 50% capital gains tax discount, however this will depend on any other capital gains and losses you may have. 

While shares do typically have greater returns over the long term, they are not without risk. There is a possibility your shares may lose value or that the company could even go under.  

Educations bonds are a type of managed investment operated by a provider. Money invested in an education bond is pooled with other investors and invested by the provider in traditional assets like cash, fixed interest, equities, and property.  

While education bonds are similar to investment bonds, they offer slightly better tax benefits and tend to invest more conservatively, which can offer some protection from market fluctuations. They are designed for investors saving for education costs either for themselves or their families.  

Education bonds can be withdrawn from for both educational or non-education purposes, however only approved educational costs will receive the tax benefit.  

As they are a type of managed fund, they often have high fees associated with them and offer limited control over where the money is invested. While this type of fund can be beneficial if you’re on a high income to reduce the amount of tax you pay, it may not have as many benefits if you are on a lower income.  

Before you open an investment to fund your grandchild’s education, it’s important to consider the following:  

• Tax and Age Pension implications: Each investment option has its own tax implications that could affect yourself and/or your grandchild. If you receive Centrelink payments like the Age Pension, it could also affect your payments. A qualified financial advisor can help you better understand the impacts to you and your grandchild.

• Personal financial circumstances: Will opening an education fund leave you without enough money to support yourself in the future? Have you accounted for costs associated with potential long-term or degenerative illness, in-home or residential aged care, or maintenance on your home? 

• Current and future grandchildren: Are you expecting any future grandchildren beyond those you already have? If so, will you open an account for them? Are you planning to open an account for each of your grandchildren? Think through the implications of each.  

• Parents of the children: Have you spoken to your children about your plans for your grandchildren? They may be on board with the idea, or they may have concerns. It’s important to discuss as a family so you can decide together on the best way forward.
  

• Time: Depending on the age of your grandchildren, will there be enough time to grow your investment before it’s needed? The more time you have, the more the investment can potentially grow.
  

• Legal considerations: While nobody wants to think about what happens if things go wrong, it’s a good idea to get legal advice and draw up clear documentation about what happens if there is a relationship breakdown, your grandchild chooses not to attend university, or if you or the grandchild passes away before the education fund is used. You may even wish to specify the gift as conditional if you want it to be used for education just in case it isn’t used for that purpose. 

• Wills: Any education accounts or investments should be included in your will, along with clear instructions around who will receive it and how you would like it to be used. You may also wish to consider setting up a testamentary trust that will arrange for a portion of your income producing assets, fixed monetary amount, or part of your estate to be distributed to your beneficiaries for educational purposes.  

This will depend on the type of account you’re looking to open, whether you are the child’s legal guardian and the differing legal, tax, and pension implications that come with opening an account in your name versus theirs.  

High interest savings accounts 

Many banks only allow the parent or legal guardian of the child to open an account in their name. If you are able to open an account in the name of your grandchild, the funds usually can’t be used for child-rearing expenses such as education, which can limit their use as an education fund, so it may make more sense to have it in your name.  

If the account is opened in their name, they will be able to access and transact from it when they reach a suitable age. The child named on the account may also be subject to tax on the interest earned, depending on the balance.  

If you open the account in your name, you have control over the account and funds. However, you will be required to pay tax on the interest earned.  

Accounts that are opened in your name can’t be transferred to another person, however any funds can be withdrawn or transferred to the grandchild or their parent as a ‘gift’. Just be aware, if you receive a Centrelink payment, there are gifting limits which if exceeded can affect your Assets test and deeming will apply. While the gift won’t need to be declared as taxable income by your grandchild, any interest earned will be subject to taxation.  

Term deposits 

Like high interest savings accounts, many banks will only allow term deposits to be opened in the name of the grandchild if you are their legal guardian and have similar rules around when the age in which the child can access it. The child may also be subject to tax on the interest earned, depending on the balance. 

If you open the account in your name, you will be required to pay tax on interest earned, even if you gift it. You also can’t transfer the account to another person.  

At maturity (the end of the selected term), you have a few options with what you can do with your term deposit account: you can renew it for another term, top it up and renew it for another term, or withdraw some or all of the balance. In the interim, you can place your funds in a holding facility while you make your decision, however if you exceed the time limit, your term deposit will be renewed at the same rate and term length (which may not be beneficial).  

If you withdraw and gift the balance to your grandchild at the end of your term, just be aware gifting limits apply if you receive a Centrelink payment.  

Shares 

Many share trading platforms will not allow you to purchase shares in the name of the child. You can however hold shares in your name and transfer these to them once they turn 18.  

Any dividends earned in that time will have tax implications to you (this will depend on whether or not tax has already been paid by the company on those dividends, or whether you own the shares as an individual or as a trust).  

Along with transfer fees, gifting shares can have complicated capital gains tax implications for you and the recipient (even more so if you are receiving Centrelink payments), so it is recommended to get qualified financial advice on whether this is the right option for you and your circumstances.  

Another option can be to open a family trust to purchase and manage the shares. While this can provide some tax benefits depending on your income, it can often come with costly fees and is not recommended for smaller investments.  

You could alternatively open an online trading account (which typically have lower fees) as a trust with you acting as the trustee for the grandchild if they are still under 18. In this instance, the child will have to pay tax on dividends earned (high taxation rates may apply for minors), which also means they will need to apply for a tax file number. 

Education bonds

Anyone can open an education bond on behalf of the ‘student’, this is not limited to being a parent or guardian and there is usually no age limit. Multiple people can contribute to the account as joint investors, however this also means multiple people can withdraw from it too.  

The provider usually pays tax on the earnings generated, in which case you as the investor will not be taxed on withdrawals, however there may be gifting implications for any Centrelink payments you receive.  

There are different tax implications for students over the age of 18 who are recipients, depending on whether they are earning more than the tax-free threshold from employment and/or other investments.  

When setting up an education fund for your grandchild, this is a good opportunity to teach them about money, budgets, tax, investing, and savings.  

Young children (four to seven years old): This is the best age to introduce what money is, what it does, and how it is used. Use everyday situations as teaching opportunities, like going to the supermarket or visiting a restaurant. Show them how different products are priced and what money you use to pay for it (cash, cards, credit card). Ask them where they think the money comes from and explain how you earned your money (such as working).  

Tweens (ages eight to twelve): This is a good time to introduce the concept of saving money. If they receive pocket money, walk them through how to set a savings goal (like buying a new toy or game) and putting money aside towards it. Check in with them to see how much they’ve saved every few weeks and discuss it with them. Don’t forget to celebrate with them when they achieve their savings goal.  

Teenagers: This is a good time to introduce more complex topics like budgets, credit ratings, credit cards, interest rates, inflation, and shares. Again, try to use everyday situations as your basis. Explain the investment option you’ve chosen for them for their education fund, how it works, why you chose it, and the tax that applies to it. This is especially important if you’ve opened a savings or term deposit account in their name, as they will be old enough to use it by this age. You might like to show them how their investment has changed over time and involve them in managing their education fund so they can see first-hand how it works. 

Sources: Moneysmart, Money Mag Source 1, Money Mag Source 2, Ratecity, Finder, Mozo, ATO Source 1, ATO Source 2, Zenith Partners