A reader wants to invest R1 000 per month for a period of 15 years towards her child’s education and wonders what the best option would be.
The key is to make sure that the underlying investment meets your timeframe. If you are only putting money away for the next two or three years, then you would want a lower-risk investment. When it comes to investing over 15 years, you need to find an investment that has returns that can beat inflation and has Iow costs. You may also want flexibility to access those funds and to pay as little tax as possible. All of these considerations need to be taken into account.
With unit trusts, exchange-traded funds (ETFs) and money market accounts, you can stop and start contributions as you wish, offering you flexibility. You can invest monthly or invest a once-off lump sum; it really just depends on your goal and your finances.
Exchange-traded fund (ETF): An ETF is a passively managed investment that tracks a basket of shares. It gives you low-cost access to invest in the market. From as little as R500, you can start putting away money for your child’s education.
Unit trust: A unit trust (also called a collective investment scheme) gives you the option of accessing all four asset classes ‒ equity, property, cash and bonds ‒ in a single investment. Any well-known asset management company will offer a range of different unit trusts in which you can invest as little as R500.
Tax-free savings account (TFSA): You can invest in an ETF or unit trust via a tax-free savings account structure. Investing for your child’s education through a TFSA is something to consider, because both the growth and income you receive on your investment are tax free. No capital gains tax and no income tax are levied on the dividends and interest received. For you to reap the full benefits of a TFSA, it’s advisable to invest for the long term. So, you could use a TFSA to fund your child’s tertiary studies if you started saving when they were still young.
If you have a longer time period of more than five years, you could consider a low-cost, balanced unit trust fund that invests across cash, property, offshore and local equities. If the balanced fund gave you an average return of 10% per annum, after 15 years of investing R1 000 per month you would have nearly R420 000 saved. Considering that your contributions would only have totaled R180 000, you would have a capital gain of R230 000 which would be taxable unless you invested via a TFSA.
While a TFSA would save you tax, keep in mind that the most you can invest in a year is R33 000 and there is a lifetime limit of R500 000. Any withdrawal that you make from the TFSA cannot be “made up” by adding in more funds above the lifetime limit of R500 000. So while there are benefits to using your TFSA to save for your child’s education, there are some drawbacks as well.
Endowment: Many insurance companies provide an endowment policy that is often called an ‘education policy’. These policies usually have a five-year restriction period in which you cannot access the funds without incurring a penalty. Endowments are normally sold as ‘tax-free’ but this is not the case. They are taxed within the fund at 30%, so if your tax bracket is less than 30%, an endowment might not be the best solution for you.
Money market account: For short-term education savings goals – for example if you are saving for next year’s school fees ‒ a money market account will do. You can also look at the various notice deposit accounts offered by the banks. These range from giving 7 days’ notice all the way up to 90 days. Generally, the longer the notice period, the higher the interest rate you get.
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This article first appeared in City Press.