Welcome to Part 2 of the 'Kids Education' Special. If you haven't read Part 1 you can find it here. In this weeks' episode we will focus on the most popular plans, policies and products by which people save for their kid's education, and share what level of return each would be expected to give you, and how it will assist you in reaching the education fund you need!
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Lets get stuck in and look at the 4 main avenues by which you can save regularly in order to accumulate your education fund. Last week we saw the various amounts one needs to save per month and the rate needed in order to generate the fund required. To achieve €55,000 in 12 years you need to save €281 per month if you get 5% Net Growth per annum, and €360 per month if you get 1% Net Growth per annum.
- Deposit Account Regular Saver:
Up until 2012 you could get up to 4/5% per annum on a deposit account, pretty sweet return for a no risk, no quablle product! Those days are over (for now), typical rate on a regular saver account are at 2% per annum Gross (circa 1% per annum).
The main advantage of a deposit account is the fact that with regards risk, there is none! Each individual account holder is covered by the Deposit Guarantee Scheme as provided by the Central bank Of Ireland, in the event that the bank in which you are saving goes to the wall!
Most of the Regular Savings Deposit Accounts will have a maximum balance of between €10k-€15k at the headline rate (of 2%). You do however have access to the funds should you need at short notice. This is a double-edge sword of course, if you are saving for education then the temptation to dip into it could easily, and often does, result in it getting eroded by temptation.
A definitive draw-back of this form of savings is that your bank is obliged to tax you on any growth each and every year, DIRT Tax (Deposit interest Retention Tax). This tax is currently at 39% having been recently reduced in the Budget. It is set to be decreased again in subsequent budgets. Having said that the fact your growth is taxed each year is a challenge, it minimises your ability to get interest on your interest (If you don't follow check out Episode #7 for a brief low-down on compound interest!).
Deposit Account therefore is a safe and stable option, will yield in the region of 1% per annum Net, meaning a €360 per month for 12 years should get you to the goal of €55,000 fund (assuming rate remains at that for the 12 years, which is unlikely; it will possibly average a bit higher than that).
2) State Savings
Most commonly these are bought through An Post (who are an 'agent', or 'seller') for the National Treasury Management Agency, NTMA. Historically the banks really didn't like the fact that this option had the distinct advantage that they were essentially tax free! You get interest and you pay no DIRT on the growth. A few years ago when rates were 4/5% per annum this was a real advantage over bank deposits, not so much anymore when rates are down at 1/2%!
Having said that the current rate on the 6 year Regular Saving Option with State Savings (www.statesavings.ie) is a meagre 0.98% per annum, or 5.5% over the 6 years. It is on a par with the Net Growth you will get on a deposit account regular saver via a bank or Credit Union, so no real advantage there at present. There is an upper limit of €12,000 per annum into these plans, so unless you are pouring it in you shouldn't have an issue! You can also access the funds with only 7 days notice, so it's reasonable accessible (again a pro and a con as above!).
3) Equity Regular Savings Products
They are also known as Equity Savings Plans, Unit Linked Plans or Pooled Regular Saving Investments. They differ from Lump Sum Investments as they are specifically designed for regular monthly or quarterly installments. These guys can be awesome, and they can be shocking! Why? Well they allow you access to the performance of various Equity Markets, Commercial Property, Alternatives etc, to whatever degree you decide. You can opt for a version with low levels of volatility and risk, or one with high levels of volatility and risk. In theory the greater level of risk the greater level of returns, however it works the other way too, the greater the risk the greater the potential falls!
We have seen Equity Regular Saving plans which invest 100% in Equity & Property have increases in value to the tune of 25% in 1 year, however we've also seen them fall in value by the same in 1 year! If you are not comfortable with that level of volatility you can opt for a more conservative option with less Equity (Shares), less Property and more Government & Corporate Bonds (lower volatility). If this all sound like mumbo-jumbo to you do check out this Podcast which explains each of these in simple terms!
One thing to watch out for with these products is the charging structure. Yes, they are designed by Insurance Companies and as such have fairly complex workings given the nature of them (Equities etc etc). They can have up front 'administration fee' of up to 5% on each installment. Hefty! A lot of them have dropped that fee but all of them will have an annual management charge (for the running of the funds and paying agents and head office employees). These charges typically range from 1% to 2% depending on the fund and the company in question. You therefore have to get at least that amount of growth each year in order to pay for having it!
You can access the money, it's not that straightforward, which I would call a good thing when it comes to saving for education! Means you can't just walk into local office and take the money out, minimising the chances we might impulsively blow the lot on a new car or kitchen units......heaven forbid! If you do withdraw money from it, it'll take you at least a week to get the funds into your account, but in addition you will usually be penalised if this withdrawal is within the first 5 years of the plan, again can be up to 5% penalty on the value of what you are taking out. Hefty!
A tangible benefit of these sorts of funds is that you can earn interest on your interest so-to-speak as there is no taxation on any growth until you cash in the value, or on every 8th anniversary of the plan being taken out, whichever is first. If you don't withdraw for say 10 years the provider is obliged to take the tax payable on the growth (difference between current value and total premiums paid= current growth). The Tax on these plans is not DIRT (because it is not a Deposit Account!) but rather Exit Tax. The rate of exit tax is currently 41% of growth, which is 2% higher than DIRT.
These pans can be really great, but only if you know what level of volatility you are exposing yourself and your money to. I would also suggest that in order to benefit and to minimise the chances of winding up with a loss you need to be prepared to leave the money for a medium to long term (7years approx), but also that if your fund happens to be 'down' when you want to withdraw that you have the option to leave it there and await it's hopeful recovery.
Typically you could expect a medium volatility fund to grow at say 4-5% per annum over a 10 year period. Net that works out at approx 2.5% per annum. Meaning saving in the region of €320 per month for 12 years to hit the €55,000.
It could do a lot better but it could also be down at any point. Nobody knows, and if anybody tells you otherwise they are lying! Personally I am a fan provided I have a good understanding of the fees and have a decent level of diversification in the funds I pick. We will cover the ins and outs of these plans in a future episode but for now that is the headline points on these guys which will be of use to our discussion here.
4) Buying Shares Directly
We kept what would be perceived as riskiest till last! This option requires the highest level of management and involvement from you, but it can pay dividends over the long term (literally and figuratively!).
You can open a 'share account' with any of the regular share 'brokers' such as Davy etc, or you can avail of some of the lower cost direct brokers available online, such as Degiro. The benefit of going with a low cost provider is obviously the fact that they are low cost! These new entrants can offer access to shares, and the likes of the increasingly popular ETFs (more on these in a future blog!) at a fraction of the cost compared to going through a traditional share brokerage, like 90% cheaper!
Generally you will pay dealer fees, stamp duty and management fees if buying ETFs or other collective investment funds which are 'managed' by a company. If you are buying shares in a single company, for example RyanAir, typically you won't pay a management fee, as there is nobody 'managing' it per se.
On disposal of shares you need to complete a tax return by 31st October the year after you made the disposal, and pay Capital Gains Tax on any profits. The current rate of CGT is 33%, which yes, is lower than the rate of DIRT and Exit Tax.
The benefits of buying shares directly are that you can access the potential return of equity markets and other asset classes via the likes of ETF, but at a fraction of the cost of investing in the likes of Equity Savings Plans as above. Having said that you do take on the management responsibility, the rebalancing, the stock selection and tax returns on sale, yourself! Most people are happy to pay a premium for others to do that, while others enjoy it, it's horses for courses.
If one had invested in an ETF tracking the S&P 500 (American Stock Market Index available through most providers) for the past 60 years you would have achieved an annual return in the region of 10% per annum. (We have already adjusted for inflation on our €55,000 college fund). After paying CGT on your profits, over the long term one could therefore expect to achieve in the region of 7% Net Growth in this Index? If you got that for the next 12 years you would only need to save in the region of €240 per month in order to reach your college fund goal!
Before one would run off and do just that it is important to note that purchasing shares is a high stakes approach, there is no capital protection of any sort and the level of volatility on the likes of this option is high, roller-coaster stuff. There have been years where this has lost 30-40% of its value, meaning if your fund was worth say 10k today, and things went really badly it could be worth 5k this time next year. That's not everyone's cup of tea!
What some folk do is they invest say 50% of their monthly installment to Equities and the other 50% to Bonds (low volatility typically), in order to turn down the volatility dial. Again, this is for another day but it gives you a sense of the type of thing one can do to try mitigate some of the risks.
So there you have it. If the goal is €55,000 in 12 years to have a college fund for 'Child 1' then these are the approximate amounts one could save in each vehicle in the hope of reaching that goal. Again, these are based on the current rates and the past performances as discussed above, all of which are guaranteed to change dramatically!!
Deposit Account Regular Saver: €360 per month (assuming 1% Net)
State Savings: €360 per month (assuming 1% Net)
Mid Risk Equity Regular Saver: €320 (assuming 2.5% Net)
Share/ETF: €240 (assuming 7% Net - which is very very optimistic!!)
Which one if for you? Only you can answer that, but at lease what you have now is a clear sense as to what each one brings to the table and the key features and benefits of each.
If nothing else it will hopefully get you thinking about the need to do some planning for kid's education, and raise awareness of the different options available. There is no silver bullet!
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Life Company Equity Savings Plan. This.....
Share Purchases. This....
State Savings. This.....