Welcome to your lesson on education bonds.

Education bonds appeal to a human desire to do the best by your children. They also appeal to the human desire to reduce the tax that you pay on your investments. So how do they work, and are they worth it?

Education is expensive. The total estimated cost of education for a child starting school in 2023 is around $87,000 as a national metro average for government schools, and $300,000 for independent schools. Regional and remote areas cost around $76,000 and $209,584. Tertiary education can cost between $20,000 - $100,000 in most instances.

Tertiary education debt is now causing financial stress for many Australians. Out of the 2.9 million Australians with an outstanding student HELP debt, 68% are concerned about the ability to pay it off. Taking on education debt flows through to have long-term impacts on the lives of many students. This includes reducing borrowing capacity if they decide to take out a home loan. On average, it takes almost 10 years for a student to pay off the loan, meaning a reduced salary for a decade. This does not account for the 10% jump in costs and higher than average indexation rates that current students have experienced, extending this time for repayment.

It is easy to see why parents are searching for the best alternative to fund these future expenses. Education bonds are a tax-effective hybrid between an investment product and a life insurance policy. These bonds can be purchased through designated institutions where the products are regulated by APRA and the Life Act.

We’re going to focus on the education purpose of the bond. However, a quick explainer of the life insurance use case is worthwhile. The bond holder is able to nominate beneficiaries for the bond, and the benefit is paid directly to them as a tax-free amount rather than included in the estate. This is regardless of the directions of the will, and there are fewer qualifications for who may be a beneficiary compared to life insurance through superannuation.

What’s the difference between an investment bond and an education bond?


There are a few similarities between an investment bond and an education bond. Investment bonds and education bonds both have avenues for tax free access, and they are tax paid investing. What this means is that these bonds pay a corporate rate of tax, at 30% within the investment. This is considered tax paid – there are no further tax events for the investor. This is lower than some marginal tax rates, which is an attractive saving for those in these tax brackets.

There is an extra benefit to education bonds – they are eligible for education benefit claims. These claims are a refund on the tax that has already been paid by the bond issuer, and it is equal to $30 for every $70 withdrawn from the earnings that you have made on your bond.

To explain this, here is an example taken from Futurity’s (an education bond issuer) Product Disclosure Statement (PDS).

Matt has a Bond Balance of $80,000, comprising $60,000 Capital Component and $20,000 Earnings Component. He wants to make an Education Benefit Claim to pay for his daughter Sarah’s (aged 19) textbooks for her first year at University, as well as a new laptop she needs for her graphic design degree. The total cost will be $5,000. Whilst the claim amount is $5,000, Matt’s Bond Balance only decreases by $3,500 (from the Earnings Component) and the balancing $1,500 is the Education Tax Benefit that Futurity is able to add on to the claim. Matt’s Bond now has a balance of $76,500, which is made up of $60,000 in the Capital Component and $16,500 in the Earnings Component. As Sarah’s part-time restaurant job only pays her around $10,000 a year, the $5,000 of additional assessable income still keeps her within the Adult Tax-Free Threshold.

However, education bonds can only receive tax benefits if they are withdrawn to serve education costs. We’ll go into what qualifies further down.

What are the rules for tax?


The bond issuer pays tax on the investment earnings (up to a maximum of 30%), and you do not need to include the earnings in your income tax return.

The 10-year tax rule is applicable to investment bonds and education bonds. This rule is that if the bond is held for more than ten years, the earnings aren’t taxed at an individual level, and it is not assessed for capital gains.

Many people consider education bonds tax-free. This isn’t exactly the case. Education bonds are taxed – they’re included in the taxable income of the recipient, and not the bond owner. Depending on their age, it is at their marginal tax rate. Minors under the age of 18 operate on a different tax rate, with the main difference being that there is a lower threshold before they must pay income tax.

For example, a recipient over the age of 18 would be able to receive $18,200 (as at 2023) in income before having to pay tax. For a minor, their tax-free threshold is $416. For this reason, many holders choose to wait until the recipient is over the age of 18 prior to funding education expenses.

What are the rules for contributions?


Education bonds have a contribution cap – the 125% rule applies. This rule stipulates that you are only able to contribute up to 125% of last year’s contributions to be eligible for the tax advantages at the ten-year mark. An example of this would be contributing $1,000 in year 1 and having a cap of $1,250 on your contributions in year 2.

The earnings are also automatically reinvested.

What are the rules for withdrawals?


The bond earnings can be withdrawn after 10 years, tax-free. This is only the case if it is used for educational purposes.

What constitutes as educational purposes? The definition is quite broad – it includes the obvious like tuition fees, but it can also include living allowances for studying away from home, boarding expenses, books and equipment.

Product Disclosure Statements (PDS) for education bonds will have a detailed listing of the applicable educational expenses.

How have they performed in the past and what are the typical investment earnings?


Education bonds can invest in any asset class. They are just a vehicle – the underlying investments could be equities, fixed income, multi-asset – or anything in between. Performance varies based on the underlying investments and there are a range of investment options comparable to a fund or ETF that you would access.

There are only a handful of providers that offer them in Australia. These include IOOF, Futurity, Australian Unity and AMP. The options offered underneath these providers do vary – for example, Futurity’s investment ‘menu’ includes offerings from Vanguard, MLC, First Sentier and PIMCO.

Generally, education bonds typically have a higher management fee than accessing investments directly. Using the same example of Futurity, you are paying for the underlying investment cost, plus 0.7% p.a. as a management fee to Futurity for offering you the ability to invest in the bond.

Many investors are now aware of the corrosive impacts of high fees. We can take a closer look at the impact a 0.7% p.a. management fee may have below.


Of course, it is important to weigh these benefits up with the tax advantages, especially if you are on a marginal tax rate above 30%. The higher your marginal tax rate, the more attractive investment bonds become. Keep in mind though – fees are a certainty; investment income is not. To have tax savings require investment income. It is difficult as investors to model the impacts as it would involve predicting future income from investments, and in turn, markets. Regardless of market movements and how much income your investment does or doesn’t give you, you will be charged 0.7% p.a. on top of the underlying investment.

What are the alternatives?


An easy way to think about education bonds is that they are collective investment vehicles like a managed fund or ETF, in a different, more tax-effective wrapper. The downside to this is that there are restrictions on what you can use the funds for to receive the tax benefit. With a managed fund or ETF, you can withdraw the funds and use it for whatever purpose you would like.

This is a consideration because as much as you can try to predict the future, it is hard to know the plans and aspirations of the recipient. There are limits to what can be spent without the recipient paying income tax as a minor, so the full benefit is realised when the recipient continues on to tertiary education – whether that be a college, TAFE or university.

Education bonds suit investors with a high degree of certainty of the future educational path of the recipient. They also suit investors that are on, or close to the highest marginal tax rate. There are many investment options for investment bonds, with varying asset mixes and fees. We encourage investors considering investment bonds to be conscious about fees, as over the long term, it can negate the tax benefits of the vehicle.

Read more from Morningstar's senior investment specialist Shani Jayamanne:

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