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Invest wisely to ensure a bright future for your children

EDUCATION is close to the hearts of most parents. At BT Money a fair chunk of the letters we receive from readers are on the topic: where should I invest my savings for my child's education, should I take out an endowment policy or rather invest in unit trust funds?

Like most areas in personal finance, there isn't a one-size-fits-all answer. The right choice depends on your personal circumstances and preferences.

What is fundamental, however, is that you start saving, today, for your children's future education costs. Whether it's private school fees, college or university fees, the cost will be even more exorbitant in the years ahead.

The most common investment product used for education savings is an endowment policy. An endowment works like this: you sign up to make annual or monthly contributions for a minimum term of five years and the money becomes available to you at the end of the period, after which you can make withdrawals as needed.

These are the arguments often put forward by insurance agents and brokers when making a sales pitch for an endowment:

  • The contributions to your endowment will continue to be paid even after your death with the premium suspension benefit.
  • The high withdrawal costs of an endowment act as a disincentive to the policyholder to dig into the fund before its maturity date and use the money for other purposes.
  • When your policy matures withdrawals are tax-free.
  • You can invest your contributions into a managed portfolio, ensuring a smoothed annual investment return.
  • The policy can be linked to life assurance cover.
  • You can borrow against the policy at any time from your insurance company. Here are some reasons why an endowment policy is not always best:
  • Adequate life cover can replace any policy's premium suspension benefit. You should have sufficient life cover to cater for your family's future needs, including education costs.
  • Yes, an endowment can mean disciplined saving - but, to too few people. The high lapse and surrender ratios of policies shows that many policyholders dig into their education savings. To my mind, too much is made of the "disciplined saving" aspect of endowments.
  • Withdrawals from a matured endowment are tax-free (the interest income has already been taxed in the fund itself), but redemptions of unit trusts are equally tax-free (unless you're regarded by the taxman as a share dealer).
  • If you want a smoothed return invest in managed unit trust funds, or in a correctly mixed suite of unit trust funds.
  • Other assets can also act as security for a loan from a bank.

    The real reason why your financial adviser will suggest an endowment policy is to earn commission. The up-front commission earned from an endowment is far higher than that earned from the sale of unit trust funds (the longer the term of the endowment, the higher the commission, so don't take out an endowment for longer than a five-year term).

    A recent, harebrained scheme I heard about involved a financial broker who advised his client to take out a 10-year endowment with annual contributions. These contributions would be financed by monthly payments into a unit trust fund, to be redeemed at the end of each year. This lucky broker stands to earn commission from both the sale of the endowment and the unit trusts.

    So what are the alternative investments for parents?

  • Your access-type of mortgage bond. Your bond is a great investment: you earn 20% (at the current bond rate) and that's after-tax.
  • A suite of unit trust funds or investment trusts. You need to do some research to find the funds whose performance is consistently above average at an acceptable risk level. But remember, equity unit trusts are a long-term investment - longer than three years. If you need the money within three years, rather invest it in your bond or a money-market related product.
  • Finally, wealthy grandparents can each donate up to R25 000 a year (R50 000 in total) to their grandchildren - in this instance for education purposes. These donations will be free from donations tax and will escape estate duty.

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