Investment Bond: A Tax Effective Way to Fund Your Child’s Education

Securing your child's financial future is a top priority for many parents. With education and living costs on the rise, starting a savings plan early can make a significant difference.

There are three main avenues to consider when saving for your child: Bank Accounts, Investments, and Investment Bonds. Each option has its own benefits and tax implications, which we will explore in this article.

1. Bank Accounts

Opening a bank account for your child is the simplest and most straightforward method. It's an excellent way to teach kids about money management and savings from a young age. However, the main drawback is taxation. If a minor earns more than $416 in unearned income, the tax rate is a staggering 66%. For example, a bank account with a balance of just $8,320 earning 5% interest would exceed this threshold, resulting in hefty taxes.

2. Direct Investments

Investing in shares, mutual funds, or other investment vehicles can yield higher returns compared to a savings account. However, if the investments are in your child's name, they are subject to the same high tax rate on unearned income. A more tax-effective approach might be to invest in your or your partner's name, but then the earnings are taxed at your marginal tax rate, which may still be quite high.

3. Investment Bonds

Investment Bonds, also known as education bonds, child bonds, or insurance bonds, offer a unique solution. These are internally taxed investments at a company tax rate of 30%. If you hold the bond for 10 years or more, any redemptions are capital gains tax-free. This makes them an attractive option for long-term savings, especially if your marginal tax rate is higher than 30%.

Investment bonds are a blend of an insurance policy and an investment, with investment options similar to those offered by industry superannuation funds. The key benefits include not adding to your tax bill, flexibility in accessibility, and the ability to nominate beneficiaries. Additionally, you can change the ownership without incurring stamp duty or capital gains tax.

However, there are some rules and limitations:

• Contributions are limited to 125% of the previous year's contribution.
• Capital gains tax benefits increase over time, with full exemption after 10 years.
• Costs are similar to industry superannuation funds, ranging from 0.6% to 1.5% per annum.
• The investment menu may be limited compared to other options.

Conclusion

Choosing the right savings plan for your child depends on your financial situation and long-term goals. Bank accounts are great for small amounts and teaching kids about money, while investments can offer higher returns but come with higher taxes. Investment bonds provide a balanced approach with tax benefits, especially for long-term savings.

For the 2025 financial year, the 30% marginal tax rate ceases at $135k, so for taxpayers earning above this, an investment bond will see a lower tax rate on the investment earnings.

For personalised advice tailored to your specific circumstances, consider consulting with a financial adviser who can help you navigate these options and create a plan that best suits your family's needs.

Want more advice? Speak to our Financial Advisor Richard Leal.

Richard Leal

Financial Advisor & Director of LINK Wealth Advisors