Education bonds can be a handy tool for families looking to save for future education costs, whether for primary school, high school, or higher education. Offering tax advantages and flexibility, education bonds provide a structured way to grow funds in a tax-effective (potentially no tax) environment.
In this article, we’ll break down everything you need to know about education bonds, so you can determine if they’re the right fit.
What is an Education Bond?
An education bond is similar to an investment bond but with a twist—it’s tailored towards education-related savings. Think of it as a dedicated investment account with tax benefits.
An education bond is a type of life insurance investment contract, meaning it comes with a few quirks that we will discuss in this article.
Investment Options
The money contributed into an education bond gets invested in line with your chosen investment strategy. Depending on the bond provider, you’ll have access to a range of investment choices, from conservative to aggressive.
It is important you choose an investment strategy that suits your risk profile and investment timeframe. The strategy you choose will determine the performance of the bond.
Before committing to an education bond, check the investment options to ensure they align with your objectives. Some providers offer a broader range than others, giving you more flexibility.
Tax Benefits
One of the primary reasons education bonds are utilised is the potential tax savings. Here’s how the tax treatment works:
- Tax-Paid Environment: Just like investment bonds, the earnings inside an education bond are taxed at a maximum of 30%, but the actual tax paid can be lower due to franking credits and offset. The taxes are paid within the bond itself, you won’t need to worry about including these earnings or capital gains tax (CGT) in your personal tax return, making it very simple to manage.
- Tax Rebate for Education: The big selling point of education bonds is that if the bond is used for education purposes, any tax that was paid within the bond is rebated. For example, for every $70 of earnings withdrawn for education purposes, an additional $30 tax rebate will be added to your account. The bond provider will apply for this rebate on your behalf. However, there may be personal tax implications applicable to the beneficiary of the bond upon withdrawal. These are discussed below.
- Tax-Free Withdrawals after 10 Years: Even if you don’t use the funds for education, after the 10-year mark, the earnings on the bond can be withdrawn tax-free (acting like an investment bonds). In this instance however, you wouldn’t get the tax rebate as the withdrawal was not for education purposes
One negative from a tax perspective that is applicable to education bonds and investment bonds alike is that they don’t receive the 50% general discount for CGT purposes.
Withdrawals
You can access your Education Bond at any time for any purpose, however the tax rebate only applies when the withdrawal is for education purposes. The capital component of the bond (the money you put in) will always be returned tax-free. Tax may be payable on the earnings component of the withdrawal, depending on the purpose of the withdrawal, who the beneficiary is and how long the bond has been operating.
Tax implications for minor beneficiaries
It is important to consider that if the beneficiary is a child below the age of 18, the earnings component is taxed at the child’s marginal tax rate (noting that the minor tax rates will apply unless they qualify for excepted income).
Given this, it is generally advisable that you choose an investment bond provider which allows flexibility to choose where the withdrawal is funded from – capital or earnings. This allows you to limit your withdrawal from the earnings component to $416 for a minor (the tax-free threshold), taking the remainder of the funds required from the capital component which is not assessable.
Where withdrawals are made for eligible education expenses, the tax rebate will be added to the earnings component of the bond. This will occur regardless of the beneficiaries age and how long the bond has been held for.
Summarising the tax on withdrawals
The table below is a summary of the tax implications of withdrawals:
| Access Type | Purpose of Access | For tax purposes, who is treated as receiving the amounts? | Tax status of amount received |
|---|---|---|---|
| Education Benefit Claims – Earnings component | Eligible education expenses | Education beneficiary – minor under age 18, not excepted income. | Minor MTRs (noting $416 tax-free threshold) |
| Education beneficiary – minor under age 18, excepted income. | Adult MTRs | ||
| Education beneficiary age 18 or over | Adult MTRs | ||
| Other Withdrawals – Earnings component | Any purpose | Bond owner – during the first 8 years | 100% assessable at MTR with 30% tax offset |
| Bond owner – during year 9 | 2/3 assessable at MTR with 30% tax offset | ||
| Bond owner – during year 10 | 1/3 assessable at MTR with 30% tax offset | ||
| Bond owner – after year 10 | Tax free | ||
| Capital component | Any purpose | Bond owner – any time | Tax-free |
Retrospectively claiming education costs
You can retrospectively claim education expenses. This means that you do not need to incur the education related cost in the same year as the withdrawal – you can claim education expenses from previous years, post the establishment of the bond. This gives you the flexibility to withdraw the earnings component for previously incurred education expenses, once the beneficiary is over the age of 18 and has access to the adult tax rates.
The 125% rule
Like investment bonds, education bonds follow the 125% contribution rule. This means that after the first year, you can contribute up to 125% of the previous year’s contributions without restarting the 10-year tax-free clock. If you skip a year of contributions, you won’t be able to contribute further without resetting the 10-year timeline.
For instance, if you contribute $10,000 in the first year, you can put in $12,500 in year two, and so on. If you don’t contribute in year two, you’ll either have to start a new bond or reset your 10-year period.
Estate planning perks
Education bonds can also be powerful estate planning tools. You can name a beneficiary, bypass the will, and ensure the funds go directly to the intended recipient—whether it’s for education or other purposes. This is particularly useful if you have complex family dynamics or want to avoid the time-consuming probate process.
Moreover, if the life insured passes away, the bond can be paid out to the nominated beneficiary without triggering any tax consequences—even if the bond hasn’t reached the 10-year mark. This can be a valuable strategy for intergenerational wealth transfer.
Fees
Each bond provider has their own set of fees which you need to consider before commencement. This typically comprises of an administration fee and a management expense ratio (MER) applicable to the chosen investment option.
One criticism of education bonds is that they add an extra layer of costs, which could be avoided without utilising the bond structure. However, unless your assessable income is below the tax-free threshold, and you can’t see it changing in the future, then the tax benefits associated with the bond often outweigh the additional cost.
The Guided Investor approach
We like education bonds! In the right situation, they offer not only tax minimisation, but also bring discipline to your education savings through the use of a regular investment plan. Being a tax-paid structure, it is also super simple to manage once established.
We would typically only recommend an education bond be established in Phases 2 and up of the Wealth Creation process. If you do not yet have a strong financial foundation, then you are not ready to invest for future education purposes. You need all the cash flow available to establish your foundation first.
