Justin's Blog

Pay University Fees (HECS) Upfront or Invest and pay at the end?

My daughter is planning to attend University next year to do a double degree which will take 5 years. I'd like to pay her tuition fees for her - called Higher Education Contribution Scheme (HECS) in Australia.  I have to decide whether I should pay them each year in advance or wait till the end of the course and pay them.  If I get a 20% discount by paying the fees up-front, why would I pay them at the end of the course and miss out on the up-front discount?

Well, I'm considering putting the same annual contribution into an investment - probably shares - and sell them when she finishes University for a profit and use the profit to pay off her HECS debt.  It sounds a little complicated and risky but after doing the maths it seems like a reasonable proposition.

The annual tuition fee is A$8,000 for the course she is considering. If I pay it up-front, I get a 20% discount, that is $6,400. Over 5 years, that is $32,000.

Alternatively, I could borrow $71,111 which has an Interest-Only repayment of the same $6,400 per annum at a 9% bank interest rate. After 5 years, I will have paid out the same $32,000 and the debt is still $71,111.

Because the fees are not paid upfront, the Government pays them through the Australian Tax Office on her behalf (without the 20% discount) and indexes the outstanding debt each June by the annual inflation rate. So, at the end of 5 years, she will owe the Government $8,000 times 5 years plus indexing for inflation (currently at 4.5% in Australia) totaling $43,766.

When she starts Uni, I take the $71,111 and buy shares in SFY which represents the top 50 companies trading on the Australian Stock Exchange. SFY is trading at $47 each at the moment for example so I would end up with 1,702 shares if I did this now. The beauty of SFY is that if the share price of one of the 50 companies takes a dive, it is wiped from the Top50 and another company share takes its place.

 If I put the shares in her name, she will get the dividends, currently running at $1.83 per share or $3,115 every 6 months for the parcel that I would buy.  That works out to be around $6,200 per annum. I'm ignoring the tax implications because they will be small as she will not be earning any other money.

Assuming that the Top50 index fund improves in value by 9% per annum - the same amount that the bank is charging me for interest, then the share investment will be worth $109,413 at the end of 5 years. Pay off the bank loan of $71,111 and that leaves about $38,302 of profit. She will loose a little of this in capital gains tax.

But she still has the $43,766 debt with the Tax Office.  Thankfully, when you pay your debt in a lump sum rather than gradually, the Tax Office gives you a 10% bonus. Hence, the $38,302 becomes $42,558 leaving a debt of only $1,208 at the end.

That is not bad when you consider she has earned dividends throughout the 5 years and there is a chance that the investment may improve by more than 9%.  Of course, there is a risk that the shares will drop in value but the longer the investment runs, the less likely they are to drop in value. 

So, that is why I'm considering paying the debt at the end.  Even if we are no better off at the end, this would be an interesting investment lesson for both of us.

Posted at 05:31PM Aug 11, 2008 by Justin Glen in Personal  |  Comments[1]