The average annual cost for a senior aged pupil was recently estimated at over £33,000 (not including extras).  School fees have increased at an average rate of 5–6% per year in recent years although in 2017/18 that fell to 3.4%.

Just the thought of having to meet school fees for the next few years can fill you with dread and saving for them so they don’t break the bank can be a real challenge. And that’s all before you start thinking about funding 3 years at university.

Paying for school fees

Cue the Educational Trust Fund

An educational trust fund can be created by parents for the purposes of funding future or existing school, college or university fees and it has some significant advantages for Inheritance Tax and also other taxes too.

An educational trust fund can be set up so as to provide income and or capital during a child’s minority and up to age 25 if the child is or will be in full time education. Any funds not used for this purpose will revert back to the parent or their estate.

Assets within the fund are protected against any future problems you might encounter such as divorce or bankruptcy. 

The tax implications

The fund isn’t exempt from tax and income payments paid to the beneficiary will be net of tax, but the child will be able to reclaim the tax paid by taking advantage of their personal allowance (first £12,500 tax free as of April 2019/20 and thereafter at 20% up to £50,000). 

tax on educational trust fund

This can compare extremely favourably to a situation where the fees are paid out of the parent’s estate (potentially up to 45%) and the tax is not recoverable.

Income accumulated by the trust for the tax year but not distributed to the beneficiary is generally taxable to the trust although the principal amount in the trust is not. That said there is some flexibility in the terms of the trust you create and you can provide for whether any income earned by the trust is taxed to the trust or the beneficiaries, be it capital gains, interest, ordinary income or dividends.

You will also be able to specify how assets are divided, whether that’s equally between your children or paid in specific amounts in specific circumstances.

Grandparents wanting to help out 

Grandparents wishing to help out with school fees or wanting to make a tax efficient disposal of their assets may want to consider a Discretionary Trust. An individual can give away up to £325,000 without incurring Inheritance Tax. By doing this it reduces their own estate by £325,000 thereby potentially saving 40% tax on this amount (£130,000).

help to pay school fees

As a couple, of course, that amounts to £650,000, which is no mean contribution when it comes to the school fees. It does take 7 years for such a gift to fall outside their estate for Inheritance Tax purposes but provided the settlor survives seven years, their IHT threshold in reinstated and they are therefore able to settle a further £325,000 upon trust after that seven year period (provided they haven’t made other significant gifts in recent years).  It should be remembered that the trust terms will preclude you from getting the money back.

Income payments from the trust are paid net of income tax to grandchildren who can reclaim the tax paid by the trustees via their own personal allowances.  There may also be savings or advantages when it comes to potential Capital Gains Tax (CGT) which, if it is payable on putting assets into trust, the donor can claim to ‘hold-over’, so that there is no tax charge until the assets are sold later (and transfers of property may also be exempt from stamp duty land tax unless there is a mortgage).

The net effect

The net effect of setting up a trust for the payment of school fees for both beneficiary and donor are significant. With funds available to pay fees, you may also be able to take advantage of early payment school fee discounts and the massive burden of meeting those termly school fees or the daunting costs of University are met, bringing both peace of mind and giving your children or grandchildren the best start in life. What’s more, significant tax savings are likely to be made.