School Fees Planning

Funding for children’s education can form a major part of an individual’s personal financial planning and this factsheet aims to give guidance on the various methods of funding for school fees, whether from income or capital, and some of the ways in which this can be achieved.

How should I fund for school fees?

The method used to finance school fees will depend to a great extent on the period of time until the fees start to be paid. As with many other investment plans, the earlier school fees plans are put in place, the greater the potential increase in returns. In addition, the investment choice is wider if there is more time for planning.

School fees can be funded from net income, a lump sum investment, regular savings or any combination of these options. Early provision will help to ease the eventual burden and can be very tax–efficient.

Considerations

The first point to consider is when the fees will become due and the likely amount. The age of the child and likely school to be attended will probably be known. Fees are normally due at the beginning of each of the three terms, although discounts are usually available if they are paid annually in advance.

Estimates of future fees can be made based on current levels (either for a particular school or an average) and on what rate the fees have increased in the past. This increase is typically well above the rate of inflation.

Once this information is known, or at least estimated, a decision can then be made as to how the school fees should be funded.

It is also important to consider who might fund the school fees. Generally, income from investments placed in the hands of children by their parents will be taxable on the parents. However, income derived from assets invested for grandchildren by their grandparents can often be more tax–efficient, because it can normally make use of the grandchildren's tax allowances and rate bands.

Funding from income

The savings vehicles used largely depend on the period of time until the fees need to be paid.

With a timescale of five or more years, much of the investment could be equity based. Specific options include shares, unit trusts, investment trusts and insurance policies, although it must be remembered that there may be a higher risk to your capital when you invest in equities and equity based investments, as opposed to some other forms of investment and you may lose some of your capital, particularly in the short term.

Regular savings

Many forms of regular savings can be used to finance school fees. For example, regular monthly payments into a growth–based unit or investment trust.

Individual Savings Accounts (ISAs) could also be used to provide tax–efficient growth of funds and existing TOISAs (TESSA–Only ISAs) can be used to provide a tax–free sum.

ISA–based savings are likely to produce a better rate of return than insurance plans for basic rate taxpayers, assuming equal investment returns. However, unit and investment trusts (whether wrapped in an ISA or not) may be more volatile than endowments. On the other hand they are much more flexible and easier to realise than insurance or annuities.

Endowment insurance policies

A typical solution has been to take out a series of qualifying endowment policies, with a term of 10 years or more. These policies mature at regular intervals to cover the fees due.

If fees are required before 10 years, then it may be possible to obtain a loan secured against a policy. The loan can then be repaid when the policy matures. Provided policies are not surrendered within seven and a half years, no tax should be payable. In addition, if policies are encashed in the early years, you are unlikely to get back what you have invested due to charges, etc.

Deferred annuity

If there are less than seven years until the fees are due to commence, a deferred temporary annuity can be used.

Monthly premiums are paid which guarantee a fixed level of fees when required. Premiums are paid during the period of the deferral and, if necessary, the fee–paying term of the policy. To protect fees upon death, life assurance can be taken out, although some schools provide cover for fees in the event of death.

Some insurance companies have unit–linked annuities which are specifically for the payment of school fees. These provide a guaranteed minimum return, which is low, to safeguard against poor fund performance.

Recent falls in annuity rates have made these plans less attractive.

Funding from capital

Once again, the period of time between when the funds are invested and when the fees are due is an important factor.

School's own plans

A number of schools offer schemes whereby a lump sum can be paid to them in advance of the child's education commencing. In return, the school will guarantee the fee level.

It is always worthwhile checking whether the chosen school has its own scheme because substantial savings can be made. However, before committing to a school's plan, it should be established what would happen to the funds paid in advance if the child did not ultimately go to that school.

Single premium insurance bonds

These work by investing a lump sum in a bond and taking advantage of the 5% per annum tax deferred withdrawals (for up to a maximum of 20 years). The 5% amount, if not required immediately, can be rolled up and taken in future years when fees are required to be paid. Any extra withdrawn over the 5% amount is taxable at the higher rate of tax, assuming you are a higher rate taxpayer at that time.

School fees educational trust

These work by making a payment to the trustees of an educational trust who invest the funds in a fixed or unit–linked annuity provided by one of the insurance companies. As the school fees are required, the insurance company pays the annuity instalment to the trustees who then pay the school.

Should the annuity instalment turn out to be more than the fees then it can either be returned to the investor and taxed as income, or some arrangement can be made with the school to use it as part payment for the next term or for extra–curricular activities. If the annuity payment is less than the term fee, the balance will be payable by the parents to the school.

There are a number of significant and complex tax issues with these arrangements, that are not covered in this factsheet and professional guidance should be sought.

Stocks and shares

Fixed interest securities, such as government gilts or depositbased investments can be used. While the return is likely to be lower there is the certainty of knowing the amount that will be paid. Although no capital gains tax charge generally arises, there could be an income tax liability.

A lump sum can also be invested in a portfolio of unit and/or investment trusts. The investment would normally be in low income, high growth units. Any gain on the units may be covered by the individual's annual capital gains tax exemption.

An ISA can be used as a tax–free wrapper for stocks, shares, unit or investment trusts. Broadly, income and gains would be tax–free.

Borrowing

If you have illiquid assets, such as property, you may wish to borrow against them to provide a lump sum for school fees. A loan could even be "linked" to a pension scheme with the lump sum being repaid out of the tax–free cash on retirement. This option is probably only worth considering where no advance provision has been made. Of course, interest will be due on the loan and life cover is likely to be required by the lender.

Summary

School fees can be very costly if paid out of current income. Starting to save early, and tax–efficiently, can mitigate the cost. Alternatively, raising capital from current resources needs thought to ensure the best route is taken. It is never too early to start, especially as you need to register as soon as the child is born to guarantee a place at some private schools. It is also important to consider your attitude towards investment risk before investing in any of the vehicles mentioned. If you are interested in finding out more about school fees or other financial planning, please contact the person who normally deals with your financial planning matters at Grant Thornton, or your local office below.