Education Bonds

I just discovered an investment structure I had never heard of: Education Bonds. These are an Australian investment structure that is similar to investment bonds but with some twists. We have an investment bond in Little My's name at Generation Life. We used it to invest the money he inherited from my mother. 

First, I will describe an investment bond again. It is an investment that pays tax in the fund nominally at 30%. If you hold it for 10 years and then withdraw the money you don't pay any additional tax. If you withdraw it before 10 years you owe tax on the earnings at your regular tax rates but get a 30% tax offset. You can reset the 10 year term by contributing a new investment of more than 125% of the previous year's investment. Why would you want to do that? If your tax rate or a child who you made the beneficiary end up having a tax rate below 30%, you'll pay less tax then if you withdraw the money.

Most of this applies to an education bond too. These are the differences:

1. You can withdraw the contributions without tax or penalty at any time. Only the earnings are locked up for 10 years.

2. You can make a claim to pay for education expenses and withdraw earnings to do so. When you do this, you get the tax paid added onto the amount you withdraw. So, there is no tax in the fund on these withdrawals. This can be done at any time, not just after 10 years.

3. The twist is that the beneficiary whose education you are paying for is liable for tax on the earnings. Children under 18 have very high penalty tax rates (one reason we used an investment bond for Little My). So, beyond the tax-free $416 per year this really wouldn't make sense. Once they turn 18, the regular adult rates apply including the tax free threshold.

4. Here is the really interesting part: You can keep any education bills incurred since you started the education bond and claim them in a later year. So, you could claim school tuition from 2026 in 2036 say!

5. If you withdraw all your contributions and then want to withdraw earnings without valid education bills, the standard investment bond rules apply.

6. The downside is you are limited to the investment options the provider has and an additional administration fee. After all, they have to deal with all these education claims... For Australian Unity this additional fee is 0.7% p.a. 

There are only a few providers and so far Australian Unity seems most attractive. Generation Life don't offer this product.

Basically, this is a way of tax-sheltering some investment income in a similar way to income splitting through a family trust. But it is much more restrictive on investments and possibly has higher fees (our SMSF pays 0.3% p.a.). You are only really going to be directly paying for higher education expenses using this.

For someone in my position, it might make sense after you have maxed out your tax free super pension and you are already above the tax-free bracket of income tax on your non-super earnings, which is true in my case. The problem is that actually trying to reclaim all the children's private school fees during the 3 or so years they are in Uni would push them into the 30% marginal tax bracket, which is probably where I will be myself. If they are working part time they might already use up the tax free allowance (currently AUD 18.2k), which would make the tax savings small. And this is assuming they go to Uni. With these considerations, the 0.7% annual fee, and limited investment options, I am undecided if this is worthwhile.