Parents of young children often buy “education plans” that are sold to them by life assurance agents. The sales pitch is quite simple and powerful – you need to start saving to ensure that you can afford to send your beloved child to school. Often mention will be made of how bad the public education system is and that private schooling is the only viable option for parents who really love their children. Whilst I like the principle of saving for your child’s education, there are easy and cheap options that are often much better than these “education plans”.
What is an education plan?
Education plans are quite simply endowment policies that have been packaged by the marketing departments of life assurance companies. You can buy an education plan and use the money for any purpose; they have no special dispensation or tax rebates, they are just ordinary endowments. Given our current tax regime, I feel that endowments are better suited to wealthy individuals and Trusts because they have very high Income Tax and Capital Gains Tax rates. If you are not at the highest tax rates, you probably won’t derive much tax benefit from an endowment. Whilst it is true that the proceeds of an endowment policy are tax free once it has matured (i.e. been going for five years or longer) the endowment pays Income Tax and Capital Gains Tax at quite a high rates of tax within the policy. I often recommend endowments to wealthy individuals or trusts but only when the cost of the endowment is totally subsidized by the fund manager and only when there are no initial costs/commissions to the endowment.
Education plans are sold by life assurance companies and they inevitably carry an upfront cost/commission as well as a pretty hefty annual cost. Unfortunately these costs are not easy to understand. By my calculations, the annual costs range from 3% to 5% per year and the upfront costs are usually similar. I feel that these costs are far too high and ultimately make education plans a poor choice for education saving.
What are the alternatives?
Government, ASISA and a selection of financial companies created an investment called FUNDISA http://www.asisa.co.za/fundisa/ that is designed to help people save for a child’s tertiary education. It is a good alternative for people who can only afford to save small amounts – the minimum starts at R40. Government will top up your contributions to this scheme by adding 25% to the amount saved annually BUT only to a maximum of R600 per year. The annual cost is reasonable at 1.25% + VAT and given the low minimum investment amounts, it should certainly be considered by those who can afford to save small amounts. It is important to note that the money can only be used for approved tertiary institutions. In addition, the underlying investment is an income or money market unit trust. I feel there is nothing better available if you are investing less than R300 per month and is certainly better than an education plan, in my view.
Exchange traded funds (ETF)
Regular readers of my articles will know that I am a huge fan of ETF’s. If you are not familiar with them, here is a link to the JSE’s website to read more.
When close friends or relatives have a child, I always suggest that they open an ETF account for their child. This is an ideal way for the parents to start saving with a monthly debit order and their friends and family can contribute to the investment on the child’s behalf. I think this is a great investment for debit orders and lump sums of R1,000 or less. If you are saving larger amounts, you could consider a stock broking account to buy your ETF’s.
If you are not a fan of ETF’s, a well managed, low cost unit trust is also a good alternative. Just make sure that the annual costs are less than 1.5% per year and that you are invested in the right type of fund. If you are saving for a period of 10 years or longer, you really should be invested in a high equity fund.
RSA retail savings bonds
If you have been a bit slack in starting your savings for your child and have a limited amount of time to save, consider the RSA Retail Savings Bonds. They have no cost and your interest is guaranteed by Government. This is ideal for people who are going to need the money within three years or less.
In summary, it makes sense to start saving for your children’s education as early as possible. In fact, you are foolish not to do so. However don’t be suckered by the first life assurance agent who plays on your emotions to sell you a policy. You have many great alternatives.
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