How to save for kids’ education

2012-03-10 10:50

An education policy provided by a life company is structured as an endowment policy. This means that the policy has a fixed term and that if you stop contributing penalties may apply.

This restriction can help maintain discipline as you cannot touch the money until the time period is over.

However, you need to understand that if you stop contributing before the investment period is over you may not receive all your money.

The reason is around half of the commission and costs for the full period of the investment have already been deducted and even if you do not save for the full period, you have paid the costs.

An alternative option is to invest every month into a unit trust and use this money to fund your child’s education.

Unit trusts tend to be less expensive and provide more flexibility; the downside is they are also easily accessible if you are concerned about being tempted to dip into the funds.

The myths
When recommending an endowment policy an adviser will give you several reasons as to why it is a good investment.

However, it all depends on your personal circumstances and in many cases these reasons are more beneficial for higher income earners than for a basic investment.

Tax relief
An adviser will tell you that an endowment policy is tax-free. This not entirely true as within the fund the interest income and capital gains is taxed at 30%.

If your personal tax rate is above 30% this can be a tax benefit.

However, for anyone earning less than R25 000 per month, they would actually pay less tax in their personal capacity which makes an endowment less tax efficient than a unit trust.

Less volatility
An endowment policy can often be structured to smooth out the returns so that the investor is not exposed to the market movements.

“Our experience in the market is there is aversion to downside risk and clients do not want to see their values decrease from one period to the next”, says John Davidge, Senior Product Developer at Old Mutual Group Schemes.

Unfortunately, any type of guarantee or protection comes at a higher price. If you are investing via a debit order every month for five years or more your investment risk is already reduced.

Should the market fall, you are able to buy more shares with your rands and if the market rises your investment is worth more.

If you select a balanced unit trust that has exposure to a mixture of cash, bonds and equities then your risk is even further reduced.

Minimum premiums
One of the main arguments advisers use to invest in an endowment over a unit trusts is that most unit trusts have a minimum monthly contribution of R300.

This may be true in the case of pure asset management houses like Investec, Coronation or Allan Gray but many of the large financial services companies and banks offer lower contributions.

For example Sanlam, Stanlib and Absa offer unit trust investments for as little as R200 per month and you can even invest as little as R50 a month through the unit trusts provided by the banks such as FNB Growth and Stanlib Equity.

Momentum has a range of funds for R100 per month, which includes lower risk investments.

Financial adviser Gregg Sneddon says in his experience fund managers are often prepared to lower their monthly contribution level.

Paying for advice
You can invest directly into a unit trust and cut the broker costs, however “many entry level investors are more inclined to give the money to an institution to manage, rather than try to manage the outcome on their own which may be intimidating,” says Rowan Burger of Liberty.

This is a valid point as many people would rather pay someone to help them navigate all the choices and fill in the application forms.

The problem is that unit trusts do not generate the same commissions as endowments and by recommending a unit trust an adviser would not be able to cover the cost of their time.

An endowment policy pays half of the total commission that the broker will earn over the period upfront. So for example if the broker would earn 5% per R200 monthly contribution for a ten year policy, rather than receiving R10 each month the broker would receive R600 upfront and R5 per month.

This helps to pay for the adviser’s time for providing advice.

A unit trust pays a maximum commission of 3% and can only be paid monthly, so the adviser would only earn R6 per month and it would take a very long time to recoup the costs incurred in assisting the client.

The commission structure is the main reason why so many endowments are sold and ultimately if you want to purchase a unit trust, investing through your bank or going directly may be your best option.

As the funds in an endowment policy cannot be accessed for the full period of the investment and penalties may apply if you stop contributing, this does create a form of discipline.

Protection from estate duty: According to Rowan Burger of Liberty, in an endowment policy, the assets remain outside the estate and are paid to a nominated beneficiary.

It is therefore a way for individuals to protect their assets from creditors and estate duty.

However, while a creditor may not be able to touch your child’s education fund, for many people the value of their estate does not attract estate duty and so the policy is again more beneficial to high net worth individuals.

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