Planning ahead for school fees and university costs
We often hear from parents and grandparents that providing the younger generations with a private education and a university degree is an important objective.
According to the latest statistics, the average private school fees are now around £35,000 per annum for senior boarders and £21,400 for senior day pupils (Independent School Council 2021) and fees are often even higher. Historically, school fees have grown ahead of inflation and this trend looks set to continue. As a result of the current sharply rising rate of inflation, this means that parents and grandparents are likely to experience considerable rises in school fees in the immediate future.
University tuition fees are up to £9,250 per annum, with living expenses on top, estimated to be in the region of £800 per month (Save the Student) and probably higher in London.
So, the cost of funding a first-class education can be a considerable expense, especially for larger families. While some may be able to simply meet the costs from income, planning ahead can be crucial, and there are a number of tax-efficient planning opportunities all should consider.
Investing for the future
The potential funding need for one child can be up to thirteen years at school and another three (or four, or five – personal experience of a parent of a Veterinary student) at university. Over such periods, despite the volatility of investment returns, a diversified portfolio including risk assets such as equities is likely to provide higher returns relative to cash in the bank, and therefore reduce the amount that needs to be set aside in the first place. With the rate of inflation being well ahead of interest payable on cash, the value of cash can be eroded over the longer term, and therefore cash should generally only be considered for fees falling due in the short term.
Using your own allowances
The simplest strategy is often to invest in one’s own name, to build a fund from which to draw as and when school and university fees later fall due. This may be relatively tax-efficient, to the extent that such investments for children can be sheltered within one’s own tax allowances, though this has the potential disadvantage of delaying when gifts are effective for Inheritance Tax purposes.
Prepaying school fees
Schools with a charitable status often offer discounts to those paying school fees up front as a lump sum, as it allows them to invest the funds tax-free themselves. This can provide a degree of certainty as to the level of future school fees, and be a tax-efficient approach where individuals would have incurred tax had they invested the monies themselves.
Using trusts
Anti-avoidance rules mean any income generated (in excess of £100 per annum) is taxed on the parent and so prevents parents from using their children’s allowances. However, this restriction does not apply to others, so gifts from grandparents and other family members can often be invested very tax efficiently. Children cannot legally hold investments until age 18, but in the meantime a simple bare trust structure can be used, with trustees holding monies on the children’s behalf, and making withdrawals from the trust as and when education costs become payable.
Bare trusts are therefore commonly pre-funded by family members (besides parents) who want to contribute to a child’s education, given this brings forward the point at which a gift is effective for Inheritance Tax purposes, and any income and capital gains are subsequently taxed as if held directly by the child.
The child’s income tax allowances and capital gains tax (CGT) exemptions are all available, including (based on 2022/23 tax tables):
Their personal allowance (£12,570 per annum)
Savings rate band (£5,000)
Personal savings allowance (£1,000)
Dividend allowance (£2,000) and
CGT exemption (£12,300)
Which can together shelter relatively sizeable tax-free income and capital gains.
One thing to consider, however, is that the child is legally entitled to any remaining funds from age 18, for any reason. These might be used towards university costs, but if benefactors or trustees would prefer greater ongoing control, a discretionary trust structure could be used instead, though the tax treatment differs from that laid out above, and is generally less favourable.
Using the children’s ISA allowances
Parents, grandparents and other family members who are comfortable with the children having access to their money in adulthood should consider using the various ISA allowances available.
Junior ISAs are available to any child under the age of 18 (those with existing Child Trust Funds can transfer into Junior ISAs). The Junior ISA allowance for the 2022/23 tax year is £9,000.
The ISA allowance is £20,000 and is in addition to Junior ISA allowances gathered from previous tax years, ISAs can grow free of income tax and Capital Gains Tax and can be accessed from age 18 onwards (or age 16 for Cash ISAs), making them potentially well suited for funding university costs.
An important point to note here is that from age 16, you are able to subscribe £20,000 to a cash ISA alongside a full JISA allowance of £9,000. This is a benefit that is only available between 16 and 18.
CAM do offer Junior ISAs, so do contact us if you’re interested.
Using offshore bonds
Another way to provide for education costs is through the use of an offshore bond. Funds within an offshore bond are able to grow broadly tax-free, and tax may only be payable when sizeable withdrawals are required from the bond.
Offshore bonds can be held within a trust structure or directly by the investor. Under a trust the transfer of cash to the trust will either be a PET (Potentially Exempt Transfer) or a CLT (Chargeable Lifetime Transfer) but the 7 year gifting clock starts immediately. The Settlor however then has no right to the capital.
Holding the investment outside of the trust provides flexibility (access to capital if needed) but the funds remain within the investor’s estate.
Offshore bonds are usually created with a number of sub policies. It is this structuring that allows for significant flexibility to the investor. A number of sub policies can be assigned by way of gift to the child (once they attain age 18) and they can then surrender the policies with tax assessed on their earnings and tax allowances, usually meaning all the chargeable gain is washed through and there is no tax to pay. This can be repeated each year throughout the child’s University tenure.
For Inheritance Tax Purposes. the 7 year clock starts from the date of the trust, for bonds in trust, or from the date of the gift, for bonds outside of a trust.
The importance of Life Cover
Consideration should be given to the need for sufficient insurance in place to cover education costs in the event of death or the inability to work. This is particularly important if fees are to be paid from earnings. Occasionally such cover is offered as part of the package from the school, or otherwise it can be taken out on a standalone basis.
Good old fashioned ‘Family Income Benefit’ is an often overlooked but efficient means of covering this liability.
Final thoughts
Discussing these options with a suitably qualified, professional adviser will help you get organised, prioritise your objectives, and ensure you do not miss out on appropriate opportunities. Investing a small amount of time now can save lots more in the long term, as well as providing peace of mind. Many of these considerations naturally link into other aspects of financial planning, such as inheritance tax and estate planning.
This article was prepared by Chris Green, a chartered financial planner at CAM. We always appreciate your feedback. If you have enjoyed this article or have any specific topics you would like to see addressed in future newsletters, please email us at FPTeam@city-asset.co.uk.