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For many parents, the academic education of their children is one of the highest goals of their lives. In earlier years, concern for their offspring was a reason for taking out an education policy. At their core, the policies were classic endowment insurance policies. Since the reduction of tax benefits, however, the love for these savings contracts has cooled noticeably. Nevertheless, many parents and grandparents continue to rack their brains over how to pay for their offspring’s education.
If we assume a study duration of five years and support of 1,000 euros per month, a university degree today leads to total costs of 60,000 euros when added up. Presumably, the expenses are even higher because the duration of studies has increased in recent years. In view of these prospects, cost-conscious parents are left with only a mixture of hardship and hope. They should not pay for self-discovery courses for their children that begin with business administration and end in sociology; instead, they must tell their children bluntly and clearly that the parental money tap will be turned off after five years.
How The Cash Value Of Studying Increases
A five-year stay at a university in Germany costs 59,000 euros once, if the child receives 1,000 euros a month, the expenses increase by three percent each year and the 60 installments are discounted at three percent each. This present value becomes higher the further in the future the start of the study program is. For example, if a child is seven years old, is due to go to university in twelve years, and the cost of living continues to rise by three percent a year until then, the present value of the studies climbs to 84,000 euros.
These sums should not deprive parents of sleep. Other generations have also coped with such problems. The optimal solution to the problem will depend primarily on the parents’ wallets. In young families, homeownership is usually at the top of the wish list. Then comes the children’s education. Finally comes private retirement planning. If money is tight at the moment, parents will concentrate all their financial power on their own home, pay off the debt on the house as quickly as possible and pay for the children’s education later out of their current income. Provided there is enough money available or grandparents offer to help their grandchildren, the question already arises today as to the right one-time investment or savings program for a course of study that will begin in twelve years.
Bonds For The Security-conscious
If the money is available and can be invested for twelve years, a one-time investment of 59,000 euros is required at an interest rate of three percent per year – as shown. If parents attach great importance to security, they should buy bonds. The simplest investment might be to buy a listed index fund on bonds because in this way the capital is spread across many bonds and investors do not have to worry about reinvesting the returns.
What may be annoying at the moment is the fact that the annual interest still has to be taxed in full. However, considering the fact that the final withholding tax will most likely be in effect in 2009, the damage is limited. The 25 percent tax on income – bonds currently yield around four percent per year – will push the return down to three percent annually.
Endowment Insurance Can Make Sense
Alternatively, it may make sense to take out endowment insurance if this investment also generates four percent each year. In this case, a one-time payment of 57,000 euros is sufficient. The money goes into a policy with a term of twelve years, and at an interest rate of four percent, 91,000 euros will be in the account at the end. The difference between the deposit and the final balance will be 34,000 euros, half of which will be taxable when the policy matures after the policyholder’s 60th birthday. This results in an after-tax interest rate of 3.25 percent, making the endowment policy the ideal gift from grandparents to grandchildren if the particular emphasis is placed on security.
Who Is Not Liquid At The Moment
The situation is somewhat different if the capital is not available in one sum today, but must be saved over the next few years. Here, two things need to be considered. First, the question of how long the savings phase will last must be clarified, and second, the question of whether the savings target needs to be hedged must be examined. The most costly solution is a savings contract over twelve years with coverage in the event of the saver’s occupational disability and death. Simpler are alternatives where the savings phase lasts only seven or eight years and the hedging can be dispensed with because sufficient money or insurance coverage is available.
Taking out a savings plan with a target sum of 84,000 euros requires 144 installments of 457 euros each if the deposits earn interest at four percent annually and are not taxed. In a pension fund, the annual return drops to 2.73 percent at a tax rate of 30 percent, so the effective installments must rise to 495 euros to reach the target. In an endowment policy with a pre-tax return of four percent, 474 euros are necessary. The benefits of endowment insurance are greater the larger the starting capital or the higher the savings rates and the more the investor is taxed. In addition, insurance policies have the advantage of lasting longer than mutual funds. Balances in annuities and stock funds are usually quickly plundered when investors feel like it. With endowment insurance, however, the reluctance is much higher because people perceive the liquidation as a loss.
The Best Solution
Despite these limitations, the best solution remains commingled mutual funds. If, for example, the target sum of 84,000 euros is divided equally between stocks and bonds, mixed returns of 5.9 percent before taxes can be achieved if the bonds earn interest at four percent and the stocks at eight percent. Of this, around 5 percent will remain after taxes on an income of 100,000 euros. Taking into account the contributions to the tax office, this results in monthly installments of 430 euros. Compared with bonds and endowment insurance, these are tangible advantages that speak in favor of taking out mixed funds and policies.
A prerequisite for success, however, is the cost of the contracts. In the case of investment funds, there is the threat of ongoing issue surcharges, which range from 2.5 to 6 percent depending on the type, and in the case of policies, fees of 5 to 6 percent of the target sum must be expected, so that the contracts start with corresponding minus amounts and only come out of the red over time. Against this background, the recommendation can only be: Index funds are the better solution, but the products are kipper goods. The salesmen in the banks only make an effort under the counter when investors threaten to migrate to the competition.