Using insurance bonds to save for school fees

Private school fees can be expensive. In major cities around Australia, it can cost upwards of $500,000 per child to fund 12 years of private schooling. This cost is not tax deductible, meaning a person in the 37% tax bracket needs to earn almost $800,000 to pay for this schooling.

Despite this, in 2013 the percentage of Australian children in non-government schools hit an all-time high of almost 40%.  So, if your clients have kids, or are contemplating kids, then there is almost a 40% chance that they will send them to a non-government, fee-charging, school. These clients will almost certainly benefit from your help in best-affording those fees.

One way that some advisers seek to help out here is to recommend an insurance bond-based savings plan to fund school fees. This is almost always a mistake, but it becomes even more so in the highly likely event that the parents of these young children will also have a relatively large non-deductible home loan. (Most parents of school-aged children do).

Insurance bond net income is taxed at 30% in the insurer’s hands. What’s more, there is no CGT discount on any capital gain that occurs. This makes an insurance bond a comparatively poor way to pay for anything, but especially an after-tax cost such as education. A far better method is to use any money that would have been dedicated to the insurance bond to simply pay off the home loan (either directly or by using an interest-offset account to negate interest). At current home loan rates of around 5%, doing so gives a capital guaranteed effective pre-tax earnings rate of about 9% pa.

Paying off debt reduces the interest expense on the home loan. When the time comes to start to pay the school fees, the money not being spent on interest can instead be used for school fees. Alternatively, the family may choose to redraw from their home loan, or withdraw money that has been deposited in an interest offset account, happy in the knowledge that the money has been create a superior, untaxed benefit until that time.

Please also remember that anecdotal evidence suggests that at least half of private school fees are funded, partially or completely, by grandparents. The above logic still holds: if your clients are, or are likely to become, grandparents, then helping their adult kids minimise their home loan is typically the best way to go about doing so.

Superannuation can be another way for working grandparents to help out here – the closer those grandparents are to being aged over 60, the better super becomes.

So please remember: the best way to pay for that new baby’s school fees is probably to pay off mum and dad’s home loan as fast as possible.

The Dover Group