I recently got a question from a friend on how I plan to save towards my kids’ college years and so I thought I’d put my thoughts into a post in case it’s of some use to others.
How much do you need?
When I first discovered the FIRE movement I was talking with friends and colleagues at work about it and I mentioned my plans to save X amount to cover my living expenses, a colleague then asked how I had planned to cover my kids’ costs at college. She had read that you need 40,000€/child to cover the costs of 4 years of college – even though third level education is mostly covered by the government in Ireland, these costs are for housing and supplies etc. Of course these can be more or less but it’s a decent guide. At the time I was of the mind set that I would not pay for my kids college education if I was not in a position to as a result of retiring early and that they could work through college and take out loans if needed but since I’ve crunched the numbers and realise that it really won’t take much to save this kind of money if I’ve got 16-19 years to do it and so I have changed my mindset as this will not overly delay my early retirement plans. Now my original mindset may seem a bit heartless but I hope that I can teach my kid about money from an early age and that they will be able to provide for themselves rather than needing money from us.
How I plan to invest
In summary my main idea is that I’d like to find an online brokerage custodial account which I can put in my son’s name. I have asked Degiro if they offer this and they said it was on their to do list but do not have one just yet. If anyone has come across an online broker with custodial accounts please do let me know! The reason I want it in my son’s name is so that the growth and any dividends are in his name for tax purposes and he will not be liable for capital acquisition tax (CAT). If I were to invest in my own name and give him the money later then he would have to pay CAT on any annual amounts over 6,000€ (see below for more on the 6,000€ amount).
Once I can start investing on my son’s behalf I will invest 12,000€ as a lump sum over 2 years, the reason I will split this over two years is again for tax purposes. In Ireland there is something called a small gift exemption where any person can receive a gift of 3,000€ from multiple sources and each gift is exempt of capital acquisition tax (CAT) up to the 3,000€, so both myself and my husband can gift a total of 6,000€/child/year without triggering CAT. The other thing to note is that this gift amount does NOT reduce the lifetime inheritance limit of 335,000€ (as of 2020 budget). More info here.
By investing 12,000€ over two years and letting it grow for 16 years at an estimated growth of 7.91% (average stock market returns of 10% minus 0.19% ETF portfolio fees minus 1.9% inflation) and paying 41% exit tax every 8 years as a deemed disposal, you will have just over of the inflation adjusted 39,000€ in the 16th year aka the future amount will show 51,240€ but will have the buying power of today’s 40,000€.
If you don’t have that lump sum to invest you can invest 100€ month for the 16 years to end up with just under 39,000€ (for a total investment of 19,200€). This just goes to show the power of compounding interest over time – that you need to invest 7,200€ more if you spread if over 16 years instead of a lump sum at the start. With the current child allowance of 140€/month/child you could technically just invest that money and have your college expenses paid for by the government. My original post stated that the 140€ was taxed but a reader kindly pointed out that this benefit is not taxed regardless of income so if you invested the full amount you’d have (inflation adjusted) 54,560€ after 16 years (for a total investment of 26,880)!
What if you don’t have 16 years?
Ok so what if your kids are older and will need the money sooner? Here is a rough guide of how much you’d need to invest if you have 4, 5 or 10 years to college years following the same investment principals – though if you need the money in 4 or 5 years then a higher risk portfolio may not be the best option but up to your level of risk tolerance.
4 years to college
If you’ve got 4 years you’d need to invest 708€month for a total investment of 34,000€ to end up with (inflation adjusted) 41,277€ in 4 years. This is 8,500€/year so your child would be liable for CAT on 2,500€ if you followed my approach above meaning they’d need to pay 3,300€ back to revenue over 4 years meaning they’d only have 38,000€ instead of 41,000€ to cover their costs. That said, in the guide linked above it does say that any excess of 6,000€/year could be claimed against the inheritance lump sum so they could avoid taxes now but lower their overall inheritance amount in the future which is something you may consider.
Another approach here could be, instead of gifting upon investment to avoid taxes on growth, to invest in your own name and only gift the 6,000€ CAT exemption limit per year in the year they need it once they are in college. As you only had investments for 4 years, the extra CAT you would pay on gains would be lower than if you had invested over 16 years. Your kid would need to cover the remaining 4,000€/year themselves through part time work or living more cheaply but then at the end of their college years they would still have nearly 30,000€ left as an investment that you could either continue let grow or continue gifting the 6,000€ year until it’s depleted which they could either reinvest in their own name or put towards a downpayment etc. If they have a partner at that point you could also gift another 6,000€ to their partner as the small gift exemption is not limited to family.
5 years to college
If you’ve got 5 years you’d need to invest 521€/month for a total investment of 31,250€ to end up with (inflation adjusted) 39,496€ in 5 years. This is just over the 6,000€ limit so you could follow a similar approach to what I suggested above to avoid the CAT on the remaining 1,000€.
10 years to college
If you’ve got 10 years you’d need to invest 220€/month for a total investment of 26,400€ to end up with (inflation adjusted) 41,094€. This is under the 6,000€ small gift exemption per year so no need to alternatives for reducing CAT.
How does this compare to other estimates?
I read another article recently which quoted varying savings amounts for 4, 10 and 16 years by investing in varying lower interest savings accounts or in actively managed funds and the monthly amounts were nearly double in some cases as the fund managers would be taking their slice of the pie or the returns in lower risk investment account would be lower.
The 4 year estimate was 100€ more per month than my estimate at 808€/month.
The 10 year estimate was to invest 11,334€ more in total compared to my 26,400€ estimate which assumed a rate of 5.4% return compared to my 7.91% (likely as the active fund would be taking the 2.51% for their cut).
The 16 year estimate was 70€/month MORE than my estimate, again likely as the active fund would be taking that as their cut. 70€ on top of the 100€ means they’d be 41% of your investment for themselves (Or 13,440€ in total). This is why fees are so important to check and understand how they compound! Especially since the article mentioned they would likely just invest it in something like the vanguard all world fund ( VWRL), which you have access to invest in yourself at a fee of 0.25%!
Anyway that’s my initial thoughts on how to save for college but I’m still searching for the custodial account which I can put in my son’s name. In the meantime I will put aside money in my own account and allow it to start growing there.
Please do let me know if you manage to find a custodial account for investment purposes!
HI Megan, really enjoying your posts….but just to confirm Child Benefit in Ireland is not taxable regardless of earnings
Oh excellent thanks for letting me know, I’ll update the post
Hi Meagan,
Thanks for the brilliant overview. Just wondering if you have managed to find a custodial account for investing?
With regards to not triggering CAT, if you have invested in ETF’s outlined in a previous blog, these are taxed every 8 years. Therefore, would the tax not already have been paid?
Hi Sean, Thanks for your comment. Unfortunately no, I have not yet found a custodial account. In terms of CAT, I believe the exit tax of 41% on gains and dividends in an ETF are separate from CAT and so in a sense would be doubly taxed. Which makes it even more pressing to find a custodial account so that you can avoid having to pay both the exit tax and the CAT.
Same thing goes for inheritance tax. If you’re investing in a non-pension account you will have paid income taxes on the initial invested amount, exit taxes on the gains and dividends and then if someone inherits the account when you pass, they will also pay inheritance tax on the total amount once it exceeds their lifetime limit.
So the government makes passive income off your investments while you take all the risk :(. They have it all worked out!
Hi Megan, sorry, please correct my understanding. if we have a custodian account, and if we gift 6k euro, every year by avoiding CAT. and using that account, we have to invest in ETF, how the child can be exempt from all taxes on the growth. like EXIT tax. ? is there is an age limit for the CGT Exit tax for the kid. ?
he will get the money from his parents by paying CAT or within the limit.
he invests the money for growth using his investment account, then on CGT, he needs to pay tax right?
or else instead of giving gifting money, we need to gift 6k worth of shares(capital asset).
let’s say, he received the gift in terms of a capital asset(shares) by triggering CAT or else within the limit of CAT. now if he realizes the gain after some year, he no needs to pay CGTtax/Exit Tax, since he already came through CAT.
you mean to say, if they apply CAT and CGT/EXIT Tax, double taxation applies, that is not tax implication in Ireland.
and also 140 child benefits will not be added to our income for taxation purpose?
Hiya, Firstly, I don’t think there is a custodian account available in Ireland yet? So if you invest on your child’s behalf in your own name then all the same taxes apply ie: you incur and file/pay the CGT/Income tax on dividends or Exit taxes/deemed disposals as normal until you sell and gift the money to your child. So no tax-free growth, unfortunately. Once the money is in your child’s name, if they invest it in their own account then they incur and file/pay the relevant taxes from there.
Yes unfortunately capital acquisition tax is like double taxation as you will also have paid CGT/income tax on dividends or exit taxes/deemed disposals on the growth.
If you have more than a million to pass onto your children it might be worthwhile looking into getting a trust set up as it can be more tax-efficient but the costs are quite high so that’s why you need quite a bit to justify the costs.
And no the 140 child benefit is not taxable as far as I know. Hope that answers your question?