We all want the best for our families and recognise that getting into the right schools can have a significant impact on the opportunities available to each new generation. Moving to the right catchment area is a priority for many families, but a private education is the ultimate aspiration. A lot of people think private school fees are tax deductible. Unfortunately, they’re not.
While private school fees are out of the reach of many young families, grandparents may often step in. Not only is the financial help much appreciated, but it can also help with your legacy planning with the potential to reduce your estate’s inheritance tax liability.
Private school fees are a significant commitment
A private education is expensive, and fees have risen significantly. When many of today’s young parents were at school in 1999, the average cost of a secondary day school education in the UK represented around 11.1% of the average gross salary of higher earners (those in the 95th percentile), as shown on the table below.
Fast forward to 2023 and Civitas reports that today’s parents are looking at secondary day school feels of around £16,654, based on 2022 data. Meanwhile, the average salary for higher earners has risen to £72,000 – so school feels now represent 23.1% of gross income, or around a quarter. And if you include boarding fees, this roughly doubles the total costs.
The cost of private school fees in relation to gross salary (higher-earners)
Sources: Office for National Statistics Percentile points for total income before tax, for tax year 1999 to 2000 to tax year 2020 to 2021 Percentile points from 1 to 99 for total income before and after tax - GOV.UK (www.gov.uk); ISIS Annual Census 1999. Civitas: Institute for the Study of Civil Society Private schooling in Britain: a snapshot
What help is available to pay private school fees in the UK?
If you’re wondering how to fund private school fees, financial support may be available. One in three private pupils receives fee assistance, through scholarships, bursaries, or charitable trusts. According to the latest survey from the Independent Schools Council, around 29% of pupils receive help of some kind with school fees, this being an average value of £6,293. There are means-tested bursaries and scholarships, discounts for military and clerical families, and for second and third children from the same family attending the same school. Lastly, itrust is an IAPS charity supporting low-income families and families with short-term financial difficulties.
Some schools also offer the option of paying a lump sum upfront, to receive a discount on future years’ fees.
If you don’t qualify for financial help, or cannot fund an up-front lump sum, then you need to start planning as soon as possible. Some things to think about are: when you are likely to start paying fees, your current children, whether you plan to have more children and the estimated level of fees and increases, as well as your income, assets and any possible inheritance.
How to think about inheritance tax and school fees
When we think about inheritances, we are often referring to post-death events. But there are ways for grandparents to pass on part of their wealth while they are still alive and reduce the potential inheritance tax (IHT) liability of their estates.
Most people are aware of the “seven-year rule”. Anyone can make any number of lump sum gifts during their lifetime and if they live another seven years the gift falls outside of their estate when calculating IHT, effectively making the private school fees tax deductible. If they die within that time the gifts need to be considered as part of their estate. And this could be useful for paying any up-front lump sum in return for reduced future fees. Less well known, you can also make individual gifts of £3,000 a year (or £6,000 per married couple). Unfortunately, this is the total value of all gifts so if you have several grandchildren at private school it won’t go far.
Another useful piece of inheritance tax planning available to everyone is something called “gifts out of surplus income”. This allows you to make as many gifts as you like, but there are a couple of conditions.
The first is they must be part of your normal expenditure. So setting up a direct debit or standing order to pay out a fixed sum per month satisfies this rule. This could be paid directly to the school, to your children to subsidise their own payments, or into an investment which is designed to pay the school fees at a later date. We shall come back to that in a moment.
The second is that these payments must genuinely be from your income after all your essential spending is taken care of. If you have to dip into your savings or investments to meet the payments, they would be regarded as having come directly from your capital wealth and therefore remain potentially part of your estate. They would become subject to the seven-year rule. Follow the link to find out more about how inheritance tax works.
Can I use equity release to pay for my grandchildren’s private school fees?
Equity release, or later-life mortgages, are becoming popular ways of releasing equity in your home to help the family with major expenses. With the rise in house values over the years this can also be a useful option, although you need to take account that interest rates have significantly increased in the past year or so as the Bank of England tries to tackle inflation.
You then have to pay back the sum released, plus the added interest, meaning this will generally cost much more over the longer term and the negative effect of compounding interest will have an impact on the debt. There could also be inheritance tax complications.
What’s the best way to plan ahead for private school fees?
As we mentioned earlier, if you plan ahead you could simply start putting money aside today with the aim of paying school fees at a later date. Cash savings can work, but even with recent increases in interest rates, the best rates available today are still falling behind inflation. Therefore, if you have five or more years ahead of you, investing is generally a better route to take as you can accept a level of risk in the hope the investments have the potential to grow faster than inflation.
But it should be mentioned investing is a longer-term option, so best to think about how you will fund school fees as early as possible. As a rule of thumb you might want to have at least three years of school fees in easily accessible cash, with the balance invested against future needs.
How do I invest for school fees?
There are two things to consider: making your investments as tax efficient as possible and deciding the amount of risk you are prepared to take. You then need to think about whether you want to invest a lump sum or make monthly contributions, or even a combination of the two.
There are several options available to you when it comes to holding your investments in a tax efficient way:
- The first basic step is to create a flexible Stocks & Shares ISA account. You can put invest up to £20,000 a year (or £40,000 per couple) and all income and growth within the account is tax free. And you can withdraw from your investments tax free, too. You can invest lump sums or regular amounts.
- As an alternative to an ISA – or in addition to an ISA – you can use an investment bond, often referred to as an “offshore” or “onshore” bond. As grandparents, you fund the bond, which is then invested on behalf of the beneficiaries. Which in this case are the grandchildren. Each bond is divided into segments which can be cashed in to pay the school fees. Part of this will represent the initial investment, and part of it the increase in the value of the investments. Importantly, any gains are taxed at the children’s tax rates. As children do not generally earn any income the tax charge is then limited.
- A third option is to use a trust which also offers tax efficiency. There are many types to choose from and each has its pros and cons. The important thing is to make sure you select the right trust for your personal situation and that of the wider family.
However, when setting up investment bonds and trusts, the original investment is treated as a gift to the trust and the seven-year rule needs to be considered, to maximise the tax efficiencies these offer.
Having decided how to hold the investments you need to consider how you will invest. To maximise returns and minimise risk, you would ideally need to hold a well-diversified portfolio across the major investment types: UK and international equities, fixed income, and commercial property. Spreading the money across these different investment assets is the best way to reduce the ups and downs of investing (“volatility”) without limiting the potential for a reasonable return.
Where can I get professional help for school fees planning?
Deciding how to invest and where to invest can be very complex decisions to make given the many variables you have to think about. This is where taking professional advice can be invaluable. Some of the options available – such as investment bonds and trusts – need careful consideration because once they have been put in place, it can be difficult to change course.
While the cost of a private education may initially appear high, the excellent academic and sports facilities, quality of teaching, small class size and high level of care and supervision, can represent a major advantage to a child’s ability to learn and flourish. For boarders, good accommodation and food and numerous extracurricular activities can all represent a very cost-effective package.
So if a private education is high on your priorities for your children, generally speaking the earlier you start the more chance you have of meeting your aims. Looking for more tips on managing your family finances? Download our free guide to help you start investing in your child’s tomorrow, today.
Past performance is not a guarantee of future returns. The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment. Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
The information in this article is based on our understanding of UK Legislation, Taxation and HMRC guidance, all of which are subject to change. The tax treatment of pensions depends on individual circumstances and is subject to change in future. This article is solely for information purposes and does not constitute advice or a personal recommendation.
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Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.
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Looking for more tips on managing your family finances? Download our free guide to help you start investing in your child’s tomorrow, today.See more