Raising children is costly with many not becoming fully financially self-supporting until age twenty-five or later. It’s an expensive business with the costs starting small and increasing as the children age.
There are school fees, sports participation costs, university and tertiary education expenses, a car, and eventually a house deposit to find. There may be unexpected or individual needs. How is best to fund these?
Many parents and grandparents put money aside for the big expenses that will come later. Grandparents have experienced the power of compounding interest. A little put aside now will amount to a lot when needed years later.
When children are young, some take the view that all spare cash should be paid off the parents’ mortgage. They say that will provide a guaranteed return and best security for the children. Later, parents can draw on the equity in their home for the children’s major costs.
Yet many people, especially the well organised, have great success by maintaining separate bank accounts for particular purposes. They don’t mix their every day living money with their long-term savings. They contribute a regular amount to savings, plus any available surpluses.
It’s easier to save for a major cost a little at a time over a long period. Having to come up with a large lump sum later without preparation is much more painful.
Managed fund savings plans can be set up to accumulate money for the major expenses of children. They involve an initial deposit and regular monthly contributions. Periodically buying parcels of shares in major companies such as the big banks, BHP and Wesfarmers can also work well.
Suppose a managed fund savings plan is started with an initial $5,000 and ongoing contributions of $200 per month. If it continues for fifteen years and earns seven per cent per annum, the end benefit will be over $77,000. That would make a major difference. Compound interest is a key to the result.
Money can be withdrawn at any time to pay the children’s expenses. One drawback when using funds and shares is that parents must declare the income generated in their own tax returns. This can mean a significant level of tax being paid.
An alternative is tax paid investment bonds. They pay a lower rate of tax internally but can be cashed in tax-free if held at least ten years. If both parents earn above $45,000 per annum, the bonds provide a better after-tax outcome.
Managed funds can start from $2,000 deposit, perhaps from a grandparent, and $100 per month ongoing, from parents. Starting a plan now will make a big difference later.