Get the Inland Revenue to ‘subsidise’ your school fees

Tax-efficient ways of funding private schooling could save all of your family thousands of pounds, says Chloe Rigby

I use the whole market, making sure clients can switch funds as and when appropriate. Diversity will see you through and school fees are a long vigil
Kevin Tooze, managing director, Equity Partners UK

Good financial planning is the key to paying school fees in the long-term and every penny that you take back from the taxman leaves you better prepared for the termly bills. As Mark Lee, chairman of Tax Advice Network, points out: “There’s no tax relief available for school fees so it’s a question of treating money in the most tax efficient ways possible in order to plan for or to fund them.”

Use your tax-free ISA allowance, capital gains allowances and your child’s tax allowances. Other members of the family can profit, too. If grandparents wish to pay for school fees, this can reduce inheritance tax paid from their estate.

There are tax-efficient savings products specifically aimed at paying school fees, although independent financial adviser Kevin Tooze, managing director of Equity Partners UK in Brentwood, Essex, says: “I don’t believe there is any specific plan that is wholly appropriate. I much prefer using the whole of the market, making sure clients can switch funds as and when appropriate for them.”

Products that he recommends at the moment are those that spread investment, such as distribution funds from companies such as Axa and Legal & General. He says: “They put money into cash, gilts and equities and spread the risk.”

For those who have larger sums of money to invest, Tooze advises using funds of funds – in which investment fund managers invest in a range of other investment funds. Here, Tooze advises using funds from companies such as Jupiter Merlin, Credit Suisse and Cazenove. “They are good for getting a good spread,” he says. “For example, if you had your money in property for the last four to five years you would have been really happy – until last year. It’s diversity that will see you through and school fees are normally a pretty long vigil.

“Casenove’s Multi Manager Diversity fund (managed by Robin McDonald and Marcus Brookes) which consists of other collective managers funds has done well to tread water,” says Tooze. “Over the second quarter of this year it has returned 1.13 per cent but as with most diverse funds the rewards are more apparent over the longer term; for example the total return over 2006 was 10.34 per cent (source Morningstar).”

The options

i. Use your ISA allowance.

If you’re saving for the long-term it’s particularly important to put the first £7200 you save each year in an individual savings account (ISA). You can save cash and invest in stocks and shares (equities) through an ISA, where interest and profits are paid tax-free. Mark Lee says: “You don’t get that much tax relief from one year, but over the years it adds up as the amount you have saved increases.”

ii. Use your capital gains tax (CGT) allowances.

You – and your child – can earn £9600 a year in income from investments before you have to pay CGT at 18 per cent. IFA Kevin Tooze says: “If parents or grandparents have capital they often overlook the fact that they or their child has a capital gains tax allowance, so they can make £9600 of gains before they have to pay a penny of tax on it. That’s roughly how much school fees cost each year.”

iii. Use your child’s tax allowances.

One simple but often overlooked measure, says Kevin Tooze, is to make sure that children’s accounts don’t suffer unnecessary tax charges. Like everyone else, children have a personal allowance that allows them to earn £6035 each tax year before they become liable to pay any tax. Tooze says: “The R85 form should be completed at the bank or building society where a child may have an account – it means they won’t have tax deducted at source.”

iv. Grandparents – and inheritance tax

Inheritance tax comes into play once the taxable value of an estate, plus the value of any gifts given in the seven years before their death, is more than the inheritance tax threshold. That threshold is £312,000 in the 2008-09 tax year. Inheritance tax is paid at 40 per cent on the part of the estate that exceeds this threshold. “Grandparents who may have a liability to inheritance tax might be looking for a way to reduce what they pay,” says Mark Lee. “Helping with the school fees is a way of taking the money out of the estate.”
He points to three ways of doing this:
o    If grandparents can give regular gifts out of surplus income, these gifts are not counted back into the estate on their death, even if they die within seven years of giving them. “It is important,” says Lee, “that this can be shown to be from income, rather than capital.” Surplus income might be from earned income, a pension or investment income.
o    If grandparents make a gift of any size and survive for seven years, the value of the gift is excluded from the value of the estate at death.
o    Each grandparent can give away up to £3000 of their capital each tax year without it being added back into the estate on their death within the seven-year period.

v. Hold investments in the name of a basic rate tax payer

If two parents are saving, and one is a higher-rate tax payer and the other is a basic rate tax payer, it’s best to hold those investments in the name of the basic rate tax payer, says Mark Lee. That’s because when tax does have to be paid on an investment, it will be paid at the basic rate rather than at the 40 per cent higher tax rate.

vi. Take it out of your business

If you have capital tied up in your own business, you may be able to withdraw cash from your business to pay school fees and then borrow to refinance the business. As long as you can demonstrate that the borrowing is for business purposes, the interest payments made to repay the loan are tax deductible. “This makes the cost of borrowing cheaper than if you had borrowed to pay the school fees,” says Mark Lee. He says it is important professional advice be sought in this scenario, since it is easy to make a mistake and end up paying more rather than less tax.

vii. Keeping control of your children’s investments

Using children’s tax allowances is a useful way of reducing the tax on investment income – but if it is also important to keep control of the money, you can hold an investment for your child through a bare trust. To do that you sign a legal document, available from savings providers, in which you announce your intention to give the child the money – but still retain control as trustee until they turn 18. By that time, the school fees will all be paid and there will be nothing left in the trust.

viii. Pensions

Those who are going to turn 50 before or while they are paying school fees can get money back from the Inland Revenue by paying into a pension and getting tax relief on their pension contributions. That means the tax they have already paid on the money they are investing is paid back into the pension. At the age of 50 they can draw down the pension, including a 25 per cent lump sum, and use it to pay school fees. Be warned, however, that both our experts say this is very much a last resort since it could have a disastrous effect on pension savings and leave little to live on in retirement.

The next step

While there are many tax efficient methods of saving that you can put into place yourself, many will want to get professional advice an independent financial adviser.

There are also many finance companies that specialise in school fees planning. Among them is independent school fees adviser SFIA (www.school-fees-planning.co.uk).

A free money makeover could help you plan for school fees

Take it further

Equity Partners UK

01277 848666

www.equitypartnersuk.com