Key Post tax and fee efficient way to save for children's education

Discussion in 'Investments' started by tvman, Nov 20, 2014.

  1. tvman

    tvman Frequent Poster

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    My first child is soon to be born and I am thinking about ways to save for his (and 1 sibling's, hopefully) 3rd level educations.

    We will be saving on a monthly basis, with an aim to have accrued a fund of c. €50K (in 2014 €) by the time they are 18.

    My wife is deeply risk averse and insists that 50% of contributions be invested in a risk free investment (will probably be a term deposit)

    I'm looking for a mechanism to access a diversified equity portfolio with minimised transaction costs and if possible minimised CGT liability, which allows regular, small investments.

    My thoughts so far is save an amount monthly and every year to split the savings in 3 and purchase EFT's in my name, my sons and his sibling's name to minimise CGT. However, looking into EFT's, they don't seem to reinvest dividend income, which would be a dealbreaker for my purposes. I'm not sure if this is the case?

    Any thoughts
     
  2. Brendan Burgess

    Brendan Burgess Founder

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    Hi tvman

    This has been discussed sporadically over the years, so I will make this a Key Thread, so that people can find it easily.

    There are no special rules for saving for children, so the ordinary rules for good long-term savings apply.

    The best long term, risk free savings plan (in fact the only one) is to accelerate repayments on your mortgage if you are on an SVR. That way you are getting a tax-free return of around 4 - 4.5% on your savings.

    You should also consider enhancing your contributions to your pension fund as that is the most tax-efficient long term savings vehicle after paying off your mortgage.

    When you get within a few years of requiring money for your children, your mortgage should be paid off and you should stop contributing to a pension to build up the required savings for college costs.

    A term deposit is certainly not risk-free. It will probably lose value due to inflation. Over the next 18 years, there could well be a banking crisis.

    Investing directly in shares is more tax efficient than buying EFTs. Losses on one can be set off against profits on the other for CGT purposes.

    Reinvesting dividends or not, is only a minor issue and should not affect the decision.

    But if you have a mortgage or, indeed, any other lending, pay that off first.

    Brendan
     
  3. Brendan Burgess

    Brendan Burgess Founder

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    I don't know the answer to this.

    Is it a good idea to put shares or deposits in the name of a child? As they will have no other income, does that make it tax free?

    If your wife has no income of her own, it might be better to put savings in her name to use up her additional 20% tax band.

    If the investment is subject to CGT, then it would be a good idea to split it up so that more annual exemptions can be availed of.
     
  4. tvman

    tvman Frequent Poster

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    Brendan

    thanks, some interesting points. A few follow ons...

    The splitting of contributions idea is aimed at maximising the cgt exemption as you say. I know little about tax so this idea may be misguided, but i will research this point further.

    I take the point about maximising mortgage payments (we plan on purchasing a home next year) - this is interesting, I will discuss this with my wife.

    I realise that term deposits are subject to inflation (and arguably but I would say very unlikely) default risk - I have had this discussion with my wife many times, she is totally averse to capital losses, so it is likely that around half the funds invested will be in risk free (however defined) investments.

    On the equity investment - my chief concern is achieving adequate diversification while minimising transaction costs. For a small, regular investment I don't think this is possible by investing in individual shares. The re-investment of dividends again is related to transaction costs - historically the larger portion of equity returns has been in the form of dividends rather than capital gains (dividends appear to be less popular today than historically, repurchases are increasingly used to distribute cash, so this may not be true in the future but dividends will presumably retain some importance). Since we will have no need for income from these investments during the period, reinvesting dividends would be prohibitively expensive (given the small amounts involved).

    Are there "regular saver" type products that are equity rather deposit based? Passive, not actively managed.

    Re pensions, there is a floor on our contributions since I am public sector and my wife's contributions are employer matched.
     
  5. whytis

    whytis Frequent Poster

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    Interesting view on paying off the mortage first.

    That does assume you're leaving time after paying the mortgage to then save up for their college.

    It's a tough question that I'm also dealing with for priorities, so I will be following this thread with interest.

    tvman - on the subject of ETFs that re-invest the dividends, they're knows as accumulating ETFs.
     
  6. Brendan Burgess

    Brendan Burgess Founder

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    I had simply assumed that you had a home already.

    You will be borrowing money at 4.5%

    To put it on deposit at 1% net after taxes.

    This is great for the banks but terrible for you, and your children.

    Lower LTV mortgages have lower rates and I expect that the difference will increase in the future. So your absolute priority is to build up as much a deposit as possible.

    Brendan
     
  7. tvman

    tvman Frequent Poster

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    Thanks Whytis - accumulating ETF's look very interesting.

    I agree about the mortgage being a superior alternative to deposits, Brendan, I don't think it necessarily means that once should not invest in other asset classes - at the same time as paying down a mortgage, although a risk free return equivalent to the SVR does make other investments harder to justify.
     
  8. Brendan Burgess

    Brendan Burgess Founder

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    Last edited: Jan 11, 2016
    Hi tvman

    I am repeatedly astonished by this point of view.

    How can it make sense to save for 18 years at 1% , while borrowing at 4.5%?

    You could justify it over a very short term e.g. within a couple of years of your kids starting college.

    You could argue that it was worth borrowing at 4.5% to invest in shares, although most people would consider that far too risky.

    Ask yourself this simple question: "Would I go to the loans desk in AIB and take out €100,000 in cash at4.5%, and then move across the floor of the bank and put it back on deposit at 1%?"

    People do it in Credit Unions all the time, because of this bizarre notion that they like to have "savings" even if those savings are pledged in full against the loan.
     
    Last edited: Jan 11, 2016
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  9. tvman

    tvman Frequent Poster

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    Brendan

    I agree with the point about deposit investments vs paying down mortgage.
     
  10. The Stig

    The Stig New Member

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    What if you dont have SVR and have a tracker?

    Have been saving the CA monthly, kids are now 8 and 5 - is the 10 year bond best place after doing initial 5/6 year childcare plus ???
    Aim is for college fund nothing more.
     
  11. IrishGunner

    IrishGunner Frequent Poster

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    861
    Hi

    Ok junior home and now the cheques and gifts are coming in. What we want to do is open up an account for them and put everything in there and also have the monthly children's allowance to go in. We hope to put in a few bob each month ourselfs and the aim is that we get the best rates and deter ourselfs from withdrawing anything, only in cases of emergency? Hopefully this will not happen.

    Looked at the savings sticky but only saw some for regular savings with BOI unless I am looking at this wrong.

    So currently what is the best options for savings for children

    Cheers
     
  12. lledlledlled

    lledlledlled Frequent Poster

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    Hi Brendan,

    I can agree with this strategy in principle. It is clearly undesirable to be saving at 1% whilst borrowing at 4.5%, which many people (including myself, but I'm trying to change!) seem to do.

    However, using the OP's example (which also appears common to many), where do you hit the 'sweet spot' where you stop paying overpaying your mortgage and begin saving for a child's college education? I think the inability to see this clearly is what make some of us continue saving in this way, even though we know it doesn't make much sense. It is much easier to see/calculate how much you will have by regularly saving on deposit.

    For example (using my own situation)...
    Child is 2 years old so I have approx 16 years to save for his college education. I estimate this will require a fund of approx €30,000.
    Assuming interest rates are so poor that they aren't worth factoring in, It's easy for me to calculate that I need to save approx €156 per month for the 16 years to acheive the 30k. So I know i 'only' need to save about €15 in addition to the Children's Allowance, which coincidentally would cease around the same time as I reach the 30k.

    However, if I'm to overpay my mortgage my the same €156 per month, I can't even begin to figure out when I'm supposed to cease over-payments and begin saving (aggressively) for the 30k. I presume the idea is that my repayments by then (assuming I opt to reduce repayments and not the term of the mortgage) will be a doddle by then and I'll save 30k no problemo. But is €156 per month really a sufficient over-payment to reduce mortgage repayments to a 'comfortable level'?
    I've attempted to use online mortgage calculators to figure this out but they tend to be biased towards those opting to reduce the term.

    Maybe a spreadsheet is required to figure out when repayments would reach a certain level. I'm afraid such a spreadsheet would be beyond my talents, but I think it would go a long way to illustrating/proving to lay-people whether overpaying a mortgage is what they should be doing.

    Any volunteers for some Excel magic?
     
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  13. shej

    shej Frequent Poster

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    Hi lledlledlled
    KARL MORTGAGE CALCULATOR is an excellent mortgage calculator that one can download as an app, it's really excellent and calculates both lump sum and regular over payments.
    I put in as an example an 156e over payment for 16 yrs on a 20 yr 270k mortgage (ie 300k house with 30 k deposit) on an SVR of 3.25% - the overpayment would give u a reduction in term of 28 mths and an interest saving of just over 13k - pretty significant saving
    Agree with BB - pay off home mortgage if on a SVR it's the most risk free savings option
     
  14. Brendan Burgess

    Brendan Burgess Founder

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    You simply can't plan this far ahead. Anything can happen over the next 16 years. You may get an inheritance. You may move home. You may get a huge salary increase. The world might be wiped out by a nuclear war. You might move home and free up lots of capital.

    So with an horizon like this, always choose the best investment now. The best investment now is to pay down expensive debt.

    Since 2014, this has become even more important with the deals available on low LTV mortgages. You will not only be saving 3.5% on the additional payments, you may well be saving 0.5% on the entire mortgage by switching to a different product or lender.

    With 5 years to go, you can review the strategy. In an ideal world with customer friendly intelligent banking, they would allow you to take a mortgage break or give you a remortgage to finance your children's education. In other words, you would be borrowing in 16 years to fund their education and not borrowing now to place it on deposit at a low rate to fund expenditure in 16 years.

    I would hope that in 16 years, banking will have been improved to allow this.

    Brendan
     
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