Saving for your child's education

Degree of intelligence &#8230; paying the mortgage can help fund studies. <i>Illustration: Rocco Fazzari</i>
Degree of intelligence … paying the mortgage can help fund studies. Illustration: Rocco Fazzari 

A very good way to save for children's education is close to home. Not all parents have a mortgage, but for those who do, the strategy is to make extra repayments and redraw the money when school fees are needed.

The beauty of the redraw is its simplicity: no tax and nothing entered on the tax return. The costs, if any, are minimal.

Some products are specifically geared towards saving for education, but they have fees and charges. And with some, if the money is not used to pay for education or training, parents do not get all their money back.

Extra money put on the mortgage, in effect, earns an interest rate that's equal to the mortgage rate because the extra repayments reduce the mortgage balance on which interest is charged. To get the same return on an investment, such as shares, the investment would have to produce a return that's higher than the mortgage interest rate because of the tax that has to be paid on any returns.

Where the mortgage strategy could come unstuck is that it requires discipline. As the mortgage is being reduced, rather than the money being put into a distinct savings plan or investment, some parents might find it hard to stick to the plan. But well-organised parents should be able to stick to the goal of earmarking the extra repayments for education. The key is to identify the extra repayments as education savings, and not just a reduction of the home loan.

To help keep the repayments separate, they could be put into an offset account that's tied to the mortgage. With an offset account, the interest that would be paid on the account is deducted from the mortgage balance.

Not all mortgages have offset accounts, but most do. Details of the offset account need to be checked, such as whether the mortgage offers 100 per cent offset, meaning the interest rate to be paid on the offset matches the mortgage interest rate. Fees and charges on the account also need to be checked. The costs of an offset account, if any, need to be compared with the lender's redraw policy. For example, some lenders may charge an administration fee for each redraw.

Parents without a mortgage wanting to save for high school fees have at least 10 years to invest if they start saving soon after the child is born. That's enough time to ride out the ups and downs of the sharemarket.

Parents could consider a portfolio of blue-chip shares that pay decent dividends. The yield on the shares is likely to be 6 per cent to 7 per cent, or even more with franking credits. Of course, tax has to be paid on the investment and there will be brokerage costs each time a parcel of shares is bought or sold.