Ahead of the 2024 general election, one of Labour’s most eye-catching manifesto pledges was to add VAT to private school fees.
Set to come into effect on 1 January 2025 – subject to a High Court legal challenge – the BBC reports that this could raise £1.6 billion a year in revenue, enabling Labour to hire 6,500 more teachers at state schools.
The policy comes at a time when school fees have already been increasing sharply. The Institute for Fiscal Studies (IFS) reports that the average cost of private school fees has risen by 20% in real terms since 2010, and by 55% since 2003, even without VAT.
While some famous schools like Eton and Harrow charge about £50,000 a year, the average across the UK is about £15,000.
If you have a grandchild at a private school, or you’re looking to help their parents to fund a private education, there are several tax-efficient options available to you. Read on to find out more.
Use your Inheritance Tax gifting allowance
In the 2024/25 tax year, you can usually pass up to £325,000 on your death without Inheritance Tax (IHT) being due. This threshold can increase by £175,000 if you leave your main residence to a direct descendant such as a child or grandchild.
If you’re married or in a civil partnership, you are normally able to transfer any unused allowance, meaning you could leave up to £1 million before IHT is due.
If this may be a concern for you, making gifts – for example, to pay for school fees – can help you mitigate any potential liability.
Each individual has an annual gift exemption of £3,000. Gifting this amount means the sum falls outside your estate for IHT purposes. You can carry forward the exemption for one year if previously unused.
So, two grandparents using their exemptions for the first time can gift £12,000 in total initially, and £6,000 in each subsequent year.
Make a potentially exempt transfer
Gifts that you make above your annual gift exemption will usually fall outside your estate providing you live for seven years after making them. This is known as a “potentially exempt transfer” (PET).
Planning early can help you to make use of this exemption.
For example, if you made a gift of as large a sum as possible (to pay several years’ school fees) you would start the seven-year clock running on the gift. This increases the chances that the gift will not be subject to IHT.
If you could gift sufficient funds to pay for the entirety of a child’s education, this could be invested so only the required sum is drawn down each year to fund the liability as it arises.
Gift from income
If you have a significant income, you may be able to use a further, powerful IHT relief.
The “normal expenditure out of income” exemption means that you can provide regular gifts, such as to pay for school fees, provided they:
- Come from income and not capital
- Do not affect your standard of living
- Are regular.
Any gift from surplus income that satisfies these requirements passes immediately out of your estate without you having to survive for seven years.
It’s important to maintain comprehensive records of income, expenditure, and gifts each year to claim this relief.
Trusts
A trust is created by a “settlor” who settles assets into the trust. These assets typically comprise property, cash, shares and so on (this would likely be cash if you are considering funding school fees).
The assets are held and managed by the “trustees” – these will typically be the child’s parents, but you could also be a trustee to retain some control over the use of funds – for the benefit of the “beneficiaries” (your grandchildren).
Bare trust
As your grandchild cannot have funds in their own name when under the age of 18, a bare trust holds assets in the name of the trustees for the grandchild’s benefit. The funds would have to be spent for that grandchild’s benefit or invested for them.
If the sum is large enough, the trustees could invest the funds and draw down each year to pay the school fees. If there was a balance left over upon completion of education, that would belong to the grandchild.
Discretionary trust
A bare trust doesn’t work if you want to set aside funds for future grandchildren or you seek flexibility as to how to provide for a group of grandchildren.
A discretionary trust is a “pot” of assets managed by trustees (that you appoint) for the benefit of the trust beneficiaries (in this case, your grandchildren).
The trustees decide how the funds should be invested and used for the benefit of those beneficiaries. Such a trust would normally be accompanied by a “letter of wishes” from the settlor (you) setting out how you would like the trust to be used.
The disadvantages of a discretionary trust are that there are costs for setting it up and running it, and the tax position is more complex.
For example, in almost all cases you are restricted to putting £325,000 into a trust. If you transfer into trust more than your available IHT nil-rate band, an immediate 20% charge arises on the balance.
Moreover, during the lifetime of the trust, there are potential charges to IHT every 10 years, at a maximum rate of 6%.
As trusts are a complex area, seeking professional advice can add value.
Finally: think about your future needs
There’s one final point to consider here, and that’s your own future financial needs.
For example, even if you are comfortable that you can provide financial support now, what would happen if you needed to fund expensive nursing care in future?
Before rushing into providing help, it’s important to review your financial position and be confident you can afford to maintain what could be a 15-year commitment.
A financial planner can help here. Using sophisticated cashflow modelling, they can establish your current and future financial position and consider the impact of any immediate or regular gifts you want to make.
This can help you to understand whether the gifts are affordable and give you the confidence to assist with school fees, safe in the knowledge your own financial position is secure.
If you’d like to explore whether helping with private school fees is an option for you, get in touch. Please email hello@bluewealth.co.uk or call us on 0117 332 0230.
Please note
The content of this newsletter is offered only for general informational and educational purposes. It is not offered as, and does not constitute, financial advice.
Blue Wealth Ltd is not responsible for the accuracy of the information contained within linked sites.
Blue Wealth Ltd is an appointed representative of Best Practice IFA Group Ltd, which is authorised and regulated by the Financial Conduct Authority.
The Financial Conduct Authority does not regulate estate planning, cashflow planning, tax planning, trusts, Lasting Powers of Attorney, or will writing.
