The cost of educating children can place significant pressure on a family’s finances. School fees are often only one part of the equation, with families also needing to budget for uniforms, technology, tutoring, extracurricular activities, university costs and vocational training.

Starting early and investing regularly can make these expenses more manageable. However, deciding where to invest is not always straightforward.

One option that may be worth considering is an education bond. Education bonds are specifically designed to help families build and manage investments for future education expenses, while potentially providing valuable tax and estate-planning benefits.

What is an education bond?

An education bond is a long-term investment structure designed to help fund the education of a nominated beneficiary, such as a child or grandchild.

Although commonly referred to as a “bond”, it does not operate like a traditional government or corporate bond. Instead, it generally works more like a professionally managed investment portfolio. Depending on the provider, investors may be able to choose from a range of investment options, including conservative, balanced and growth-focused portfolios.

The bond owner retains control of the investment and can usually nominate one or more education beneficiaries. This can make education bonds useful for parents, grandparents and other family members who want to establish a dedicated pool of money for future education costs.

Education bonds can generally be funded through:

• An initial lump-sum investment
• Regular monthly contributions
• Additional contributions over time
• A combination of lump sums and ongoing deposits

The underlying investments may include Australian and international shares, property, fixed interest securities and cash. The appropriate investment option will depend on the investor’s time frame, objectives and tolerance for market fluctuations.

What expenses can an education bond cover?

Depending on the terms of the education bond, withdrawals may be used for a wide range of approved education expenses.

These may include:

• Primary and secondary school fees
• University and tertiary education costs
• TAFE and vocational training
• Textbooks and learning materials
• School uniforms
• Computers and other educational technology
• Tutoring and specialist learning support
• Student accommodation
• Certain extracurricular or educational programs

The definition of an eligible education expense can vary between products. Before making a withdrawal, it is important to check the bond’s rules and retain the required invoices, receipts or other supporting documents.
How are education bonds taxed?

Education bonds are generally structured as life insurance investment products. Tax on investment earnings is paid within the bond rather than being distributed directly to the investor each year.

The bond provider generally pays tax on earnings at a rate of up to 30%. However, the effective tax rate may be lower because the underlying investment portfolio may benefit from deductions, franking credits and other tax offsets.
While money remains invested, the bond owner will not generally need to include the bond’s annual investment earnings in their personal income tax return.

This may be attractive to investors whose marginal tax rate is higher than the effective rate paid within the bond. It can also simplify annual tax reporting because the investor does not usually receive separate taxable distributions each year.

Some education bonds also provide an additional education-related benefit when withdrawals are made for approved education expenses. This benefit is designed to reflect some or all of the tax previously paid within the bond on the earnings component of the withdrawal.

The precise calculation and eligibility rules vary, so the tax treatment should be reviewed carefully before investing or withdrawing money.

Education bonds and the 10-year investment bond rule

Education bonds may also incorporate the taxation rules applying to investment bonds.
Under the investment bond rules, withdrawals made after the bond has been held for at least 10 years will generally not create additional personal income tax for the bond owner, provided the relevant contribution rules have been satisfied.

Withdrawals made earlier may have different tax consequences:

• During the first eight years, the assessable portion of the investment earnings may be included in the investor’s taxable income.
• During the ninth year, one-third of the assessable earnings may be included.
• During the tenth year, two-thirds of the assessable earnings may be included.
• Once the full 10-year period has been completed, withdrawals are generally received without additional personal tax.

Tax offsets may also be available to recognise tax already paid within the bond.

These rules are most relevant when money is withdrawn for purposes other than qualifying education expenses. Education-related claims may receive different treatment under the specific terms of the education bond.

Understanding the 125% contribution rule

Investors can generally continue contributing to an investment bond without restarting its original 10-year tax period. However, contributions made in a bond year should not exceed 125% of the contributions made during the previous bond year.

For example, when $10,000 is contributed in the first year, up to $12,500 could generally be contributed in the following year without restarting the 10-year period.

If contributions exceed the permitted amount, the 10-year period may restart for tax purposes. This can have important consequences for families who intend to increase their contributions significantly in later years.

A regular savings plan should therefore be established with the 125% rule in mind. It is also important to understand how the bond provider defines the bond year, as this may not necessarily align with the Australian financial year.

Potential benefits of education bonds

A dedicated investment for education
Keeping education savings separate from everyday bank accounts may make it easier to remain committed to the goal. The investment can be clearly identified for the future education of children, grandchildren or other beneficiaries.

Tax paid within the bond
Investment earnings are generally taxed within the bond. This can reduce annual tax administration and may be beneficial for investors who would otherwise pay tax at a higher personal marginal rate.

Access to diversified investments
Education bonds commonly provide access to professionally managed portfolios containing a range of asset classes. Diversification can reduce reliance on the performance of any single company, sector or investment.

Flexibility over beneficiaries
Some education bonds allow the owner to nominate multiple beneficiaries or change how benefits are allocated between family members. This can be helpful when education needs differ between children or change over time.

The owner retains control
Unlike placing an investment directly in a child’s name, the bond owner generally controls the investment and decides when withdrawals are made.

This can prevent the child from automatically gaining control of a large investment balance when they reach adulthood.

Estate-planning flexibility
Education bonds may allow beneficiaries to be nominated to receive the investment following the owner’s death. Depending on the bond structure and nomination, benefits may be paid directly rather than being dealt with through the estate.

This can provide greater certainty about who receives the investment, although education bonds should still be considered as part of the owner’s broader estate plan.

No annual distributions to include in a tax return
Unlike many personally held managed funds, education bonds do not generally distribute taxable income and capital gains to the investor each year.

This may make them easier to administer, particularly for investors who make regular portfolio changes or switch between investment options.

What are the risks and disadvantages?

Education bonds can provide useful benefits, but they will not be appropriate for every family.

Investment returns are not guaranteed
The value of the bond will depend on the performance of its underlying investments. Growth-focused options can rise and fall significantly over shorter periods.

The investment option should be selected with the expected education time frame in mind. Money required for school fees in the next year or two may need to be invested differently from money intended for university expenses in 15 years.

Fees apply
Education bonds may charge administration, investment management and transaction fees. These costs reduce the investment’s overall return and should be compared with alternative investment structures.

Contribution limits need to be monitored
Exceeding the 125% contribution threshold may restart the 10-year tax period. Families who expect to make irregular or substantially larger contributions should seek advice before doing so.

Tax benefits depend on individual circumstances
An education bond should not be selected solely because its earnings are taxed within the structure. Investors on lower marginal tax rates may find that another investment structure is equally or more tax effective.

The value of the tax treatment will depend on factors including the investor’s taxable income, investment time frame, contribution pattern and intended use of the money.

Accessing the funds early may affect the strategy
Although withdrawals can generally be made, taking money out early or using it for non-education purposes may produce different tax outcomes. It may also leave less money available when education expenses arise.

Education bond versus investing in a child’s name

Investing directly in a child’s name can appear simple, but special tax rates may apply to unearned income received by minors.

These rules are designed to discourage adults from transferring investments to children solely to obtain a lower tax rate. As a result, investment income above certain thresholds may be taxed at penalty rates unless an exemption applies.

An education bond is generally owned by an adult or another eligible entity, with the child nominated as an education beneficiary. This allows the owner to retain control while avoiding the need to hold the investment directly in the child’s name.

Education bond versus a mortgage offset account

Some families prefer to place their education savings into a home loan offset account.
An offset account can provide a guaranteed benefit equal to the interest saved on the home loan. Funds are also readily accessible and there is generally no investment-market risk.

However, an offset account does not create a separate investment specifically for education. The money may be more easily absorbed into other household spending, renovations or major purchases.

An education bond may offer greater long-term growth potential, but it also carries investment risk and fees. The most suitable approach depends on the family’s mortgage, tax position, time frame and comfort with market fluctuations.

Education bond versus a family trust

A family trust can provide considerable flexibility over how investment income and capital gains are distributed among eligible beneficiaries.

However, trusts can also involve establishment costs, annual accounting expenses, trustee responsibilities and more complex tax reporting.

An education bond is generally simpler to establish and maintain. It does not usually require annual trust tax returns or distributions, although it may offer less flexibility than a properly structured family trust.

Who might consider an education bond?

An education bond may be worth exploring for:

• Parents saving for future school or university costs
• Grandparents wanting to contribute towards their grandchildren’s education
• Families on higher marginal tax rates
• Investors seeking a dedicated long-term education portfolio
• Families wanting to retain control over money set aside for children
• People seeking to nominate beneficiaries as part of an intergenerational wealth strategy
• Retirees wanting to establish an education legacy for younger family members

Suitability will depend on the investor’s personal circumstances. An education bond should be compared with options such as mortgage offset accounts, direct investments, managed funds, superannuation, family trusts and ordinary investment bonds.

How much should you contribute?

There is no single amount that will suit every family.

A suitable savings target should consider:

• The number and ages of the children
• Whether public, private or independent schooling is planned
• Expected university or vocational education costs
• The number of years before the money will be needed
• Existing savings and investments
• The family’s available cash flow
• The expected rate of investment return
• The effect of fees, tax and inflation

Even relatively modest regular contributions can build over time when investment earnings are reinvested. Starting earlier also provides more time for compounding and may reduce the amount that needs to be contributed later.

Is an education bond right for your family?

An education bond can provide a structured and potentially tax-effective way to prepare for future education expenses. It may also offer useful investment, beneficiary and estate-planning features.

However, the benefits need to be weighed against investment risk, fees, contribution rules and the availability of alternative strategies.

Before establishing an education bond, it is important to consider:

• Who will own and control the bond
• Who will be nominated as beneficiaries
• When the money is likely to be required
• Which education expenses are expected
• The appropriate investment risk level
• Whether regular or lump-sum contributions will be made
• The investor’s marginal tax rate
• How the bond fits with the broader financial and estate plan

Case study: Building an education fund for two children

The following example is hypothetical and is intended to demonstrate how an education bond may be used as part of a long-term savings strategy.

James and Emma have two children, aged five and eight. They would like to start putting money aside for future secondary school, university and vocational education costs.

They currently have $20,000 available to invest and can afford to contribute an additional $500 per month.
Their main priorities are to:

• Keep the education savings separate from their everyday bank accounts
• Retain control of the money while their children are young
• Invest for long-term growth
• Avoid receiving annual taxable investment distributions
• Have the flexibility to use the money for either child as education expenses arise

After reviewing their options, James and Emma establish an education bond with both children nominated as education beneficiaries.

They invest the initial $20,000 and arrange regular contributions of $500 per month. They select a diversified growth investment option because the majority of the money is not expected to be required for at least 10 years.

Assuming an average net return of 6% per year, their education fund could grow to approximately:

Time invested                           Estimated value
5 years                                        $60,000
10 years                                      $115,000
15 years                                      $188,000

These figures are estimates only and do not represent guaranteed returns. Actual results would depend on investment performance, fees, tax, contribution timing and any withdrawals made along the way.

When their eldest child begins secondary school, James and Emma can make withdrawals for eligible education expenses such as school fees, uniforms, textbooks and a laptop.

Several years later, the remaining balance may be used for university fees, vocational training or other approved education costs for either child.

Because the bond is held in the parents’ names, James and Emma continue to control when the money is accessed and how it is allocated. Their children do not automatically gain control of the investment when they turn 18.

The education bond also allows James and Emma to keep the investment separate from their normal household savings, making it easier to track their progress towards their education funding goal.

What this case study demonstrates

This example shows how an education bond may help a family:

• Combine an initial lump sum with regular contributions
• Build a dedicated pool of money for future education expenses
• Invest across a long time frame
• Retain control over how and when funds are used
• Support more than one child from the same investment
• Potentially benefit from the tax treatment available within the bond

An education bond would not automatically be the best option for every family. James and Emma would still need to compare it with alternatives such as using their mortgage offset account, investing personally, establishing a family trust or using a standard investment bond.

Professional financial advice can help determine whether an education bond is appropriate and how it should be structured alongside your other savings, investments, debts and long-term financial goals.

The information contained in this article is general in nature and does not take into account your objectives, financial situation or needs. Tax and investment rules can change, and the features of education bonds vary between providers. You should consider obtaining personal financial, taxation and legal advice before making a decision.