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Picture: 123rf.com
Picture: 123rf.com

Question:

I recently gave birth to my first child. I am concerned about the cost of good education at school and for her tertiary studies. I am torn between taking out an education policy for her and putting a similar amount in a unit trust. What is the difference between an education policy and saving through a unit trust?

— Name Withheld 

Answer:

Congratulations on your first child! May there be a wonderful journey ahead for you! 

I would always recommend starting a pure investment product (unit trust) for a child. Education policies are normally relevant more in cases of a parent’s death, disability or illness. The policies may also be high-fee structure products that tend to have a low payout value in the end — and their flexibility is limited. You might have a child who participates in four kinds of sports in high school, for example, for which money might be needed. 

I would recommend opting for a normal voluntary or “flexible” investment. The concept is a lot like a bank account — you are allowed to make additional contributions at any point, and you may also withdraw at any time should there be unforeseen expenses for your child.

We follow an investment strategy that includes different asset classes: cash, bonds and growth assets (equity exposure, both local and offshore). This ensures higher returns than just leaving the money in the bank. 

The minimum contribution here is normally R500 a month. If you were to save that amount and increase it in line with inflation every year (6% in this calculation), assuming an average annual return of 10% for 18 years, you will have a lump sum of R424,117.52 to work with. If you make it R1,000 a month, it will give you R848,235.05.  

I would also recommend considering starting a tax-free investment for a child. 

Such an investment, if used optimally, offers one of the most incredible opportunities to build wealth in a tax-efficient manner. But as only one of these investments is permitted in a person’s lifetime, consider that you might be taking the opportunity to have one from your child, who might want to remain invested for longer than the time you have in mind.

You are allowed to invest R36,000 a year and R500,000 in a lifetime. This applies to the contributions invested; the value of the fund can grow infinitely. If you invest the full R36,000 annually, it will take you 14 years to reach the maximum limit. Because of the nature of the investment, and because interest, dividend and capital gains tax are not a problem, the recommendation would be to invest 100% in equities. You can enjoy the upside of growth assets (equity exposure) in this product without the  downside of tax implications that normally become a problem with discretionary funds.

You can enjoy the upside of growth assets (equity exposure) in this product without the downside of tax implications that normally become a problem with discretionary funds

If you could leave these funds for another 10, 20 or even 30 years, you can accumulate quite a significant portfolio. And the proceeds will be tax free. Allowing this investment enough time to reap the benefits of compound interest, you can essentially build your (or your child’s) retirement around it. You will be able to earn an income that is tax free.

For this reason, my advice would be to have a much longer-term mindset about this investment and not use it 20 years down the line.

If we assume an annual growth rate of 10%, the R36,000 invested every year over 14 years will grow to R1,052,463.91.

If we view this as a retirement option, we normally recommend a 5% drawing of fund value. If the investment accumulates an average return of 10% for another 40 years, your child would be able to retire, with a monthly (tax-free!) income of R198,473.88 (not inflation adjusted). Not bad for just spending some time in the market.

Elke Brink, PSG Wealth, Stellenbosch

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