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Weighing up a tertiary savings scheme

Fundisa seems great on the surface, but is it?

This article explores the pros and cons of investing in ‘Fundisa’ – a savings initiative subsidised by the government and open to all citizens.

Fundisa is a joint initiative between the government and the Association for Savings and Investments in SA to promote and encourage saving for tertiary education. Four of the country’s largest asset managers (Stanlib, Old Mutual, Coronation and Investec) have launched Fundisa-affiliated products. It works as follows:

  • All South African citizens are eligible, provided that study is started before the learner reaches the age of 35, and that the course or degree is through a recognised public college or university.
  • Government will supplement the parent’s contributions by 25% per annum, or a maximum of R600. So parents must save R200 per month to benefit from the full subsidy. Contributions over this level won’t receive any government subsidy.
  • Funds saved will be channeled into approved Fundisa investments – limited to income-based unit trusts with the major asset managers listed above.
  • If the funds are paid directly to a tertiary institution for education, then it is reportedly considered tax-free. We interpret this to mean that there will be no capital gains tax paid when the investment reaches maturity and the funds are used for education.
  • If you stop contributing or take money out of the scheme for any reason, you lose all subsidies that have accrued to you. However, you can transfer it to another learner without losing the benefits.

As such three questions must be answered:

1. Does the benefit of the government subsidy compensate for being forced to invest in income assets only (cash and bonds)? None of the Fundisa-approved investments have exposure to equities.

2. Is the ‘tax free’ status merely a marketing slogan or does it really make a difference?

3. Is a monthly saving of R200 sufficient to cover the requirements of tertiary education?

1. To subsidise or not?

The idea of a government subsidy is always appealing, but more so in an environment where our taxes seem to cover so few of the basic services. Intuitively, an extra 25% per annum on your contribution seems irresistible and a ‘no-brainer.’ We believe there are two icebergs. Firstly, the subsidy is on the annual contribution only – not the annual amount of the cumulated investment. In other words, the subsidy gets less meaningful each year as the base gets bigger. Secondly, does the subsidy compensate for the lower returns from cash and bonds rather than being invested in equities?

We ran the numbers for various scenarios, trying to eliminate bias. As Fundisa’s been around for about three years, there are a few years of actual returns to gauge accuracy.

In this exercise, there are three important variables: inflation, the annual return from shares and the annual return from cash and government bonds.

An annual research study (by JP Morgan) which starts in 1960, tracks the annual performance of shares, bonds and cash relative to inflation over the last 52 years. As a reference guide, we have used this data from 1980 onwards.

As an aside, all three asset classes have, on average, beaten inflation over the past thirty years, but less so more recently, as low interest rates have taken their toll on cash returns.

Our base scenario assumes an investment of R200 per month –the amount required to earn the maximum government subsidy – for the next eighteen years, despite inflation’s depreciating effect.

Each year the Fundisa investment is credited with R600 from the government. Equities grow at inflation plus 4% (we assume inflation is 6%), with bonds growing slightly ahead of inflation, and cash in line with inflation. As you would expect, an investment into Fundisa will grow more quickly in the early years than a similar investment into an equity unit trust, because the subsidy is large relative to the amount of capital invested. Interestingly, it takes ten years for the equity investment to overtake the Fundisa investment.

However, after eighteen years, the equity investment will have an accumulated value of R121 000, versus R103 000 for the Fundisa investment. The equity value is 20% higher.

In all the scenarios that we have painted (base, pessimistic and optimist forecast), an investment in an equity fund would yield a higher final result than an equivalent investment through a Fundisa-linked investment.

Actual data for the last 32 years, shows that an investment in unit trusts would have outstripped Fundisa by a huge margin – almost 75%.

So it seems it’s better to investment in an equity unit trust with no subsidy on offer, rather than through Fundisa with a government subsidy.

2. Is ‘tax free’ worthwhile?

Reportedly, any money saved through Fundisa will be tax-free provided the money is used to fund a learner’s education. We cannot find any reference to this tax free status in the official literature relating to Fundisa, but have done the analysis nonetheless. Given that any contribution to a savings scheme is done with after-tax savings (ie, your salary after tax has been deducted), we assume that ‘tax free’ means that there is no capital gains tax applicable when the investment matures and is used to fund education.

Based on current rates of capital gains tax, an investment in an equity unit trust will still beat an equivalent investment in Fundisa, even after capital gains tax has been paid on the investment.

Don’t be fooled by the ‘tax-free’ marketing mantra. It doesn’t alter the basic investment case.

3. Is R200/month enough for a university degree?

One limitation of the Fundisa Scheme, in our opinion, is that the subsidy offered by government is limited to R600 per annum, implying the maximum that should be saved to benefit from the subsidy is R200 per month.

A quick browse through various university websites suggests that one year of study for an undergraduate degree costs about R40 000 (tuition, books etc) – in today’s money.

We used the investment value (after tax) from an equity investment and Fundisa investment, and the cost of one year of study 18 years hence – assuming an inflation rate of 6%. In every instance the projected cost of future tuition is greater than the accumulated savings, although it’s marginal if we use the actual data over the past thirty two years as a future guide.

However, it’s fair to say that saving R200 per month is far from sufficient to meet the costs of a university education – let alone residence fees, allowances, cars etc, that are part and parcel of a child spreading his or her wings.

As to what level of savings is necessary, we calculate that the required monthly savings should be between R600 and R700 per child.

These calculations make for sober reading – especially for a father of three young boys. At first glance, the obstacles might seem insurmountable, but observing a few time-honoured practices will reduce the mountain to a manageable ‘hill:’

  • Start early.
  • Save regularly.
  • Increase your monthly saving by inflation each year. None of the examples increased the contribution by inflation each year. But it’s normal practice to increase the amount as your salary increases. If we escalate the contribution in our base scenario by inflation (starting today at R200 per month), the final value after eighteen years is R172 350 (after tax) versus our calculation above of R117 161. So while it won’t meet the target, raising your savings rate each year will go a long way to bridging the gap.
  • Ultimately, let the compounding process work for you.

Be patient and save regularly, and what once seemed impossible will gradually move within your reach.

*Michael Porter is CIO at Harvard House Investment Management.

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