Key Post What is the best way to save for children's education?

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tvman

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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.
 
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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.

If you do choose to invest in an ETF or directly in a portfolio of shares, 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
 
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As this is a Key Post I will anticipate some of the later questions so that people don't need to read the entire thread.

One question frequently asked is "I have 18 years to go. At what stage do I stop paying down my mortgage and start saving? Is it two years before college or five years before college? Even overpaying my mortgage now, I will still have a mortgage in 18 years and will not have a fund for my children. Whereas if I save €200 a month for 18 years, I will have a fund of €43,000."

The right thing to do now is to pay down your mortgage. Putting money on deposit at 0% while you could be saving 3% by paying it off your mortgage makes no sense at all.

You can't plan 18 years ahead. Anything could happen. You could get an inheritance. You will probably move home. You might be able to remortgage your home. So pay down your mortgage now.

Review the plan about 5 years before your children go to college. It may still be correct to pay down your mortgage, if you still have one. Or it may be correct at that stage to stop overpaying and build up an education fund. Because you have been overpaying your mortgage for 13 years, your mortgage payments will be a lot lower and so you will be able to save more each month.

The right long term thing to do is to pay down your mortgage. But circumstances change and you must review this strategy about 5 years before you need the money.
 
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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.
 
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.
 
tvman said:
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.

.
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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
 
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.
 
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.
 
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Brendan

I agree with the point about deposit investments vs paying down mortgage.
 
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.
 
Brendan Burgess said:
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.
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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?
 
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
 
lledlledlled said:
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.
Click to expand...

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
 
Just wanted to chime in on here since the last post was a few years back now and the SVR has been coming down in most banks in recent years.

I am looking to put around 10k aside for my two kids education. Brendan's post about paying off the mortgage makes total sense but I am wondering if instead of putting the money in a deposit account, I invested it for 15 years then hopefully it would earn more than I would save by knocking the 10k off my mortgage (especially considering I'll probably have another 10 years to pay on it). I am 1.5 years into a 5 year fixed rate with KBC at 2.8% so that ties my hands in regard to paying it off for another while anyway.
 
I’ve my mortgage paid off but can’t find any accumulating etfs. Anyone able to point me to one?
 
bungaro said:
I invested it for 15 years then hopefully it would earn more than I would save by knocking the 10k off my mortgage
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After all costs and taxes? It's certainly possible but it's definitely not a sure thing that your investment will outperform the mortgage cost over 15 years.

In your shoes, I would just pay down the mortgage as soon as possible.

I thought KBC allowed borrowers to overpay 10% of the balance during the fixed rate period without a break fee but perhaps that practice has changed.
 
My wife wants us to have the money for education set-aside in cash. That’s probably not the optimum approach, but I’ve agreed.
 
I’ll do my best to set-out the various options here.

- You can obviously save the money on deposit with a bank or credit union, but the interest/dividends will obviously be negligible. Inflation won’t be your friend but equally there’ll be no volatility so the nominal value will remain constant.

- The life companies have products for this exact scenario. They have advantages and disadvantages. Money on the way in is subject to a 1% government levy, so only 99% of your money is invested. There’s a flat 41% tax on realised gains or on any unrealised gains every 8 years. A big advantage is that all tax obligations are dealt with at source; the life companies calculate and remit the tax so no tax return is required. This is attractive for people who crave simplicity or who don’t already submit a tax return. The life companies have their critics, but it’s hard to argue with their investment and accounting resources so their equity and balanced funds tend to do fine on a relative basis and there’s minimal tax leakage under the bonnet. Some people have an issue with the fees; I’m not convinced as 0.75%-1.00% Annual Management Charges (AMCs) for what aren’t big numbers isn’t bad and, although they’re not obliged to make full MiFID cost disclosures, their Total Expense Ratios (TER) as expressed in form of Reduction in Yield (RIY) aren’t too bad.

- One could invest directly via a platform or stockbroker. It’s possible to get ‘ordinary share tax treatment’ via shares, Investment Trusts, and US ETFs. Regulated funds are subject to the same 41% tax rate as above, albeit with no 1% levy. But you have to submit a tax return. And the ITs, shares, REITs, and ETFs pay income so there’s ongoing income tax/PRSI/USC leakage. There’s also the question of who’s picking the investments. And US ETFs are now hard to access for ordinary investors. Yes, you could buy something like Berkshire Hathaway (Buffett’s basket); it is diversified to a degree but not fully.

Then there’s the question of the risk tolerance for the money. If we’re talking about ‘children children’ (i.e. toddlers, 6 year olds, etc), two children aged 6 and 3 just to make it real, and private secondary school plus college etc, we might start drawing, say, €7k a year around 7 years from now, then €7k for 3 years, €14k for another 3 years, €19k for 3 years, €24k for 1 year, and and €12k for 3 years. I’m assuming four year degrees and €12k cost of college fully loaded. That number can vary massively depending on where the parents live and the child goes to college.

The whole thing is almost like an endowment fund. We have 7 years of clear runway and then predictable enough cashflows. €229k of outflows basically. Our overall time-horizon is around 18 years. Given that this is family stuff and education related, it’d be unusual for people to be embracing too much volatility (i.e. how much it goes up and down).

IF IT WAS ME, this is what I would do:

I would go for a hybrid of the life company option and the cash deposit option. I would pick the Irish Life or Zurich Life 100% equity fund option and pair that up with a deposit or credit union account plus State Savings if possible. The split would be 60%/40% equities vs cash. I would assume a 5% return on average from the invested portion of my capital and then work out how much I need to set-aside every month. I would negotiate hard on the management charge and I would look for the life company to effectively cover the 1% levy for me via increased allocation (e.g. 101% of what I put in so net 100% post levy). They’d do this because they’re getting 0.75-1.00% per year from me every year on the whole lot.

One could of course invest in the life companies’ balanced fund instead and avoid the messing with cash accounts etc.

Based on real ‘back of the envelope’ stuff (i.e. sitting here in my garden with no laptop, Excel, or scientific calculator), I’d estimate circa €1,000 a month would need to be put in to cover that €229k expenditure using those return assumptions (i.e. 5% on the invested 60% part, or 3% on the overall).
 
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If it's simplicity you want, pay down your mortgage. It's a tax-free return.

Gordon Gekko said:
I would assume a 5% return on average from my investment
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Hi Gordon

So you are assuming a 13% return after costs and before tax on the equites fund?

Have I done the maths right? I am assuming 1% net on the deposits which might also be optimistic.

=(60%*0.6*13%) +(40%*1%)
 
Brendan Burgess said:
If it's simplicity you want, pay down your mortgage. It's a tax-free return.



Hi Gordon

So you are assuming a 13% return after costs and before tax on the equites fund?

Have I done the maths right? I am assuming 1% net on the deposits which might also be optimistic.

=(60%*0.6*13%) +(40%*1%)
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Hi Brendan,

No, I mean the invested portion.

I will edit it to make it clearer.

Thanks,

Gordon
 
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