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In 2014, shortly after reading the Barefoot investor*, I opened an education bond for my eldest child. Australia’s most popular finance book recommended an education bond for high earners. Read on to find out my experiences on the education bond, pros and cons. I have no affiliation with Australian Unity or other education bond providers, so this is an unbiased review as a consumer.
Education Bond Review: Set-Up Process
You require a financial advisor to set up an education bond. If you are among the minority who have found one they like and trust this is no issue. For those that don’t need a financial advisor, or have not been able to find one yet that they feel is trustworthy, this is a major stumbling block. Results include:
- Procrastinating for months to years
- Getting talked into something inappropriate by a financial advisor/sales person
- Finding an honest and reliable financial professional who will guide your investing over the next decades
My financial advisor talked me into signing my super over to his management in 2016. He charged a 4% annual fee! He was very convincing that his superior management would more than compensate for the fee.
This may not come as a surprise to the savvier amongst you. It didn’t.
What can I say, I was naive and way too gullible.
Education Bond Review – Tax Benefits
Education bond earnings are taxed at the corporate rate of 30%. This avoids the punitive unearned child tax rates (up to 68%) or even the adult’s marginal rate of up to 45%.
Earnings withdrawn from the bond to pay for education expenses after 10 years benefit from that 30% Tax being refunded. So as long as you follow all the rules, these investments can be tax-free.
The investment has to be started in an adults name if a child is under 10 years old, but this can be transferred to a child without incurring a taxable event at aged 16.
Education Bond Review- Rules, Rules and More Rules
Apart from the brief 3 years the financial supervisor spent playing with my super, the education bond has been my most complex investment so far.
There are rules upon rules in this thing. All else being equal, it’s obviously easier to have simpler investments!
The appeal of the education bond is all in the tax benefits. Not following all the rules means missing out on tax benefits. Rules include
- Minimum initial contribution of $1000
- Maximum contribution of $590,000
- Minimum regular savings contribution $100 monthly
To be eligible for the full tax benefits
- Earnings must not be withdrawn before 10 year investment period. There is a partial tax discount from 8 years.
- No more than 125% of the previous years contributions can be contributed each year. You can, however open multiple accounts if you have another lump sum to invest.
- Earnings withdrawn to pay education expenses get the 30% corporate tax rate refunded. These can include tuition fees, books, uniforms and a “living away from home allowance” of currently $8,200 per year.
Change of Circumstances
The Aussie Doc household set up an education fund back in 2014, while both adults were working. The intention was to save for our toddler’s tertiary education costs.
At the time Mr Aussie Doc was on the 37% marginal rate, myself on the top tax bracket. The education bond, therefore, appealed due to the tax-free earnings.
In 2016, Mr Aussie Doc became a stay at home dad, a change in circumstance we hadn’t planned in advance. Now with the kids in school, he works a few hours but is still not hitting his tax-free threshold. There is no plan currently for Mr Aussie doc to return to work for significantly more hours or pay, but if the right job came up it could happen. Who knows what we’ll be up to in another 7 years!
With Mr Aussie Doc now on the 0% marginal tax rate, the education bond has no tax advantages for us.
Luckily, the education bond does allow withdrawal of contributions, tax-free and without penalty. In 2019 we withdrew our $25,000 contributions, leaving ~ $5000 in the fund. We can withdraw the remainder for education costs (school fees) from 2024.
Australian Unity offers 15 different investment options within the bond. The word “Bond” is confusing. This investment is nothing to do with bonds you can invest in. The education bond is just another vehicle, like your superannuation, in which all sorts of investments can be contained.
We ended up with “Perpetual balanced growth. It is actively managed by Australian Unity. The current asset allocation is:
- 35.2% International equities
- 31.78% Australian equities
- 27.4% Money market
- 4.91% Australian fixed interes
- Other 0.78%
- Global fixed interest -0.07% (not sure how)
7 years ago when I set this up, I knew pretty much nothing about investing. I trusted my financial advisor to select an appropriate investment.
In retrospect, I probably should have spent a bit of time learning for myself and choosing an appropriate investment appropriately. I did eventually!
Over the past 5 years, this portfolio has produced 5.3% growth per annum. Over the same period, the ASX 200 has produced ~ 10.27% total net annualized returns. The Vanguard diversified high growth fund. The Vanguard balanced index fund returned 7.47% over the past 5 years.
My education bond has underperformed comparable investment products, such as the Vanguard balanced index fund more than enough to wipe out any tax benefits.
And yet again, it all comes down to fees I suspect. Australian Unity, like many financial product providers, like to break down the fees. They charge an admin fee of:
- 0.7% of invested amount
- An investment management fee of 0.25%-1.1% of balance on top of the admin fee, depending on exact investment choice.
- Some of the investment choices also charge a “performance fee” of 0.02-0.03% to reward investment managers for beating benchmark performance.
So in summary you will pay between 0.95-1.83% of your balance in fees per year.
The Vanguard balanced index fund we compared earlier charges 0.29% of the balance in management fees. I’m not recommending this fund, just providing some context to these fees. Superannuation fees tend to be a bit higher (perhaps to change when Vanguard start super), but Scott Pape suggests keeping fees under 0.85%.
Even the Australian unity product disclosure statement warns a 1% increase in fees can lead to 20% underperformance over 30 years!
On a more positive note, there are no contribution or withdrawal fees with Australian Unity. Over the long term, it is cheaper to pay brokerage and avoid account keeping fees.
Vanguard personal investor are now offering completely fee-free transactions (no brokerage or account fees) on Vanguard managed funds! The only fees I can see apply is the 0.29% per annum management fee and 0.5% on any money earned in a cash account.
Alternative for saving for your childrens’ education include
- Buying a broad based index fund and paying tax according to marginal tax rate (It will probably outperform despite higher tax)
- Buying Australian foundation investment company in child’s name and selecting the DSSP option to defer any taxation until your child reaches adulthood
- Open a microinvestment account in an adults name (advantage being you don’t have to select investments yourself)
- Save in an offset (but with sub 3% returns you could do a lot better)
- Purchase an investment property. Depending on your time frame you could sell it, or plan for it to be positively geared and fund child’s education.
Education Investment Bond Review Summary
Education bonds appeal to high taxpayers and those who want to avoid working out which investments to buy. It requires involving a financial advisor to open the account. My education bond drastically underperformed the ASX and similar managed funds over the past 7 years.
The good news is that if you have already signed up for an education bond and now regret it, you are able to withdraw all your contributions without penalty. There is likely to have been little growth so you will be able to withdraw the majority of your balance.
If you are still considering an education bond from Australian unity (formerly Lifeplan), read the Product disclosure carefully.
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Aussie Doc Freedom is not a financial adviser and does not offer any advice. Information on this website is purely a description of my experiences and learning. Please check with your independent financial adviser or accountant before making any changes.