Being a parent working towards owning your home carries with it many dilemmas. One such quandary is funding education for your children.
While the best option will depend on your family’s specific circumstances, two important strategies to consider are:
1. Direct spare cash into the home loan and use redraws to fund education costs.
Benefits of this strategy:
• Reduces the total amount of interest paid on the home loan.
• After-tax investment return is equal to your home loan interest rate – risk free!
• Invest amounts that are income and capital gains tax-free.
• Easy access to your cash if required sooner than anticipated with the flexibility of an offset or redraw facility available with some home loan products.
Problems with this strategy:
• Offset account or redraw facilities are not available with every home loan.
• Financial institution may charge a fee to redraw payments in advance.
• Could achieve lower returns than alternative investments.
2. Investing in a managed fund dedicated to funding educational costs.
Benefits of this strategy:
• Can choose a mix of assets to suit timeframe and desired investment return.
• Many funds allow regular investing which takes advantage of dollar cost averaging.
Problems with this strategy:
• Income and capital gains tax are generally payable on managed fund investments.
• Investments made within a managed fund are subject to market fluctuations. In times when investment markets perform poorly, returns on the fund may be low or even negative, but this is often more than offset with high returns during the good years.
• Most funds charge entry, exit and/or administration fees.
Other important factors to consider:
Investment timeframe before children start school: Managed funds are usually a long-term investment (from five to seven years plus). If your timeframe is less, investing in a managed fund is not usually recommended due to the risk that you may receive less when you withdraw the funds than you originally invested.
Time before retirement: Not many people want to pay a home loan with their retirement income. Generally speaking, the further you are from retirement the more sense it makes to use the home loan to fund education costs.
Interest rates: How much interest are you paying on your home loan? If your rate is higher than the managed fund return, it usually makes more sense to focus on paying down your home loan and invest separately in a managed fund.
Investing wisely: High penalty tax rates exist for income earned by minors. This makes investing in the name of a child under 18 undesirable.
Our team of professionals and award winning financial planners are at hand to help with any questions you may have regarding this article.
Call on (02) 4926 2300 or email us.
Funding education can be confusing, so if you’re not sure what would work best for your family, talk to us.
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