Having a plan of action in place on how you will pay for your child’s private school fees is always a good idea, and one way to lessen the burden financially is to investigate tax efficient investment structures.
Your starting point, as with any type of tax planning, should always be to decide exactly what you want to achieve. So before you consider the range of school fees savings plans, ask yourself questions such as:
- How many children is the savings plan for?
- What time period should the savings plan cover?
- Does your savings plan need to be flexible, for instance, to accommodate a new baby?
- What makes up your portfolio of assets?
- What kind of access to your capital do you want to arrange?
- What does your overall financial situation look like? Are you paying into a pension? Are you self-employed?
- Looking at the kind of return a savings plan may provide, what do you need to pay current school fees and cover any future rise in fees?
There are numerous investment structures available to you, and various tax planning tools, that may be suitable for your school fees savings plan. One of the most popular tax efficient structures is the trust.
How does a trust work with a school fees savings plan?
Setting up a trust can be a tax effective way for parents to save towards their children’s school fees while retaining a usually high level of control and protection of their investment.
There are several different kinds of trust that may be suitable for a school savings plan:
Family business trusts
As suggested by the name, the main advantage of a family business trust is that it is intended to cover family expenses.
Eligibility for a family business trust requires that the parents own shares in a family-run business, and that the grandparents are willing to make a contribution towards their grandchild’s school fees.
Further eligibility requires the possibility for the trust to hold shares in the family business, with the intention that dividends payable on those shares will be held by the trust. The family business trust may also take advantage of the child’s tax-free personal allowance to avoid such dividends pushing the parents into the higher tax rate.
Setting up a family business trust can also be a useful way to plan for handing over a family business to the next generation.
Using a trust to save for your child’s school fees can also offer a level of protection for the capital involved.
One factor to take into consideration when setting up a family business trust, however, is whether the transfer of shares and assets involved will have any implications for inheritance tax or capital gains tax.
A bare trust, the most simple and straightforward category of trust, is established with a stated set of beneficiaries from the outset. Exactly how the capital and income will be distributed is also stated when the trust is entered into.
A common use of bare trusts in regard to school fees savings plans is where grandparents wish to contribute to their grandchild’s school fees. Their grandchild is specified as the beneficiary and the grandparents stipulate that any income from the trust is used to pay that child’s school fees. The capital asset held by the trust will eventually be paid to the grandchild once they reach 18 years of age.
One commonly recognised benefit of using a bare trust is that assets may be transferred to a minor, who as the trust beneficiary then takes ownership of those assets for tax purposes, but control over those assets still remains with the settlor until the child turns 18. By reducing the settlor’s estate, any later inheritance tax liability can be lessened.
However, a bare trust does not allow the opportunity to make changes, for instance to add a beneficiary on the birth of a grandchild.
The administration costs of a bare trust are usually low, and the reporting requirements are generally more simple than with other kinds of trust.
Under a discretionary trust, the control of the capital and income is totally at the ‘discretion’ of the trustees. Where this can prove useful is the scenario where numerous parties make contributions to the child’s school fees and where a level of flexibility is required, for instance, on the regularity of contribution and the amount.
Beneficiaries do not have an absolute right to the capital or interest income of a discretionary trust because the trustees are wholly responsible for making decisions regarding how that capital and income are treated and distributed.
However, the decisions made by the trustees should be in the best interests of the beneficiaries, which in this context would be the payment of school fees.
The added flexibility of the discretionary trust does mean that it incurs higher levels of set-up cost, and more complicated administration requirements.
An additional factor, when considering this type of trust, is that because the beneficiaries do not have any ownership over the trust capital and interest income, all trustees will face a high rate tax liability, although this may be slightly offset by nominal allowances.
Using a trust for a school fees savings plan – what are the implications?
Whether a trust is the right way for your family to pay for your child’s school fees, and if so, the type of trust you choose, will depend largely on your family’s financial circumstances, but taking a look at the wider tax implications must always play a part of that decision too.
Should you choose to use a discretionary trust to pay for school fees, you should be aware that there could be inheritance tax to pay on assets transferred to, held in, or transferred out of this kind of trust. As mentioned above, this is down to the fact that the beneficiaries of a discretionary trust do not have ownership of the trust-held capital or income for tax purposes. Business property relief and other exemptions may, however, offset a level of inheritance tax liability.
When considering a bare trust, any gift made into that trust will be treated as a potentially exempt transfer, incurring no immediate inheritance tax liability.
Should the person making the gift live for more than seven years afterwards, there will be no inheritance tax liability on that gift.
The amounts that can be transferred into a trust with no resulting inheritance tax liability are:
- up to £325,000 for an individual, or
- up to £650,000 for a couple.
The factor to bear in mind when considering whether your trust will incur income tax is that of ownership of the trust income.
Where the trust is discretionary and the beneficiaries have no absolute right to the involved capital and income, the trust is taxed at the relevant trust rate. In this situation, most of the income will become taxable at the highest income tax rate of 45%. This rate is for non-dividend income.
Where the trust is not discretionary, for instance, in the case of a bare trust, the income is assigned to the beneficiary for tax purposes, bringing into play their personal allowances and a basic tax rate where applicable.
However, where a gift is paid into a bare trust from a parent to a minor child and the income for that tax year is more than £100, the gifting parent will be taxed on that income.
Capital gains tax
One of the benefits of holding a discretionary trust is that assets standing at a gain may be transferred into such a trust without incurring a capital gains tax liability at that time, on the condition that the settlor and their dependants receive no benefit. So that the asset is received by the trustees at the same value as the settlor, any gain on the assets may be held over.
In the case of a bare trust, any gain on a transfer of assets into the trust will incur capital gains tax.
If a gain is made on the disposal of any trust-held asset, there may be a capital gains liability.
Use of trusts in a school fees savings plan
When considering the use of a trust for a school fees savings plan, it is always necessary to consider your aims for that trust (simply to pay school fees or also to pave the way to hand over your family business to the next generation?), what is required from that trust (is flexibility a fair trade for a simpler set-up and administration?), and what the wider tax implications are for your family?
The answers to any of these considerations will come down to your personal circumstances and plans for the future.