PASSING ON YOUR WEALTH

Can paying your grandchildren’s school fees be a good way to reduce potential inheritance tax liabilities?

  • 20 January 2021
  • 15 mins
  • Private education is often appealing but frequently expensive.

  • Grandparents may be able to reduce their inheritance tax bills by helping out with school fees.

  • Speaking to an adviser could help you achieve this in the most tax-efficient way.

We all want the best for our grandchildren. We’d also like to reduce our inheritance tax (IHT) bills. Could paying for your grandchildren’s school fees be a good way to achieve both aims?

The private school edge

For many, giving their children or grandchildren the best opportunities means private schooling. This is reflected in attendance figures, with more than half a million children currently going to private schools in the UK. According to the 2020 census of the Independent Schools Council (ISC), the body representing private schools in the UK, this is the highest number since records began in 1974.

Strong academic results are certainly part of the appeal. The ISC census report goes on to say that ‘nearly half of A-level entries at ISC independent schools achieve A* and A grades, nearly double the overall national figure.’ Also, encouragingly, the majority (51%) of ISC pupils who continue to higher education go to the ‘Top 25’ group of universities as defined by the Sunday Times Good University Guide.

The ISC report highlights not only the academic excellence offered by private schools, but the provision of specialist teaching like music and special needs, along with smaller class sizes, excellent facilities and a wide range of extracurricular activities.

Private education can be expensive and is increasing in cost

But according to the census, private schooling doesn’t come cheap. The average cost per term for day schooling was just under £5,000, with boarding coming in at around £11,700. And fees are rising; this represents an increase of between 3% and 5% respectively from last year’s census. Of course, fees vary from region to region with average fees ranging from £3,700 per term for day schools in the North West to just under £6,000 per term for day schools in London. And that’s the average. You’ll need very deep pockets indeed to fund a residential place at a top boarding school.

The bank of gran and grandad

The Bank of Mum and Dad has had a lot of press for years now, but grandparents are also getting in on the act. According to an August 2017 survey by SAGA, a third of grandparents admitted they’d given grandchildren some sort of financial boost. And many grandparents realise that by giving money to family early, possibly when it’s more needed anyway, they could reduce the inheritance tax bill on their estate later.

How inheritance tax works

According to the government’s website, in the tax year 2020/21, IHT is levied at 40% on the value of your estate above your £325,000 exemption, known as the nil rate band. This rises to £500,000 if you own your own home and leave it to your children or grandchildren, this is known as the main residence nil-rate band. So a couple could pass on up to £1 million before inheritance tax would need to be considered. However, if your estate is worth more than £2 million; you lose £1 of main residence nil-rate band for every £2 above £2 million.

If your estate excluding your home is worth more than £325,000, including any gifts made in the previous seven years, those gifts will be added back in when calculating any IHT liability.

Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

Regardless of the size of the inheritance tax bill, it’s hugely unpopular, with many feeling that they’ve paid enough tax already while they’re alive, and paying more after they’ve died seems a step too far. According to a January 2020 article in the FT Adviser, even MPs described the tax as “unfair” in a report published by the All Party Parliamentary Group.

Related articles: Inheritance tax: a complex labyrinth and How can I help my grandchildren invest for their futures?

Gifting could reduce your inheritance tax bill

So, giving money away and living another seven years can be a very tax efficient thing to do, if you can manage it. To avoid cash gifts being subject to IHT, giving your family members money at least seven years before you die means that it becomes exempt from IHT. This is known as the inheritance tax gift seven-year rule.

Inheritance tax planning: sooner could be better

But what if you die within seven years of gifting money to your loved ones? Well according to the government’s website, the tax rate applied to the gifts tapers from 40% (if the gift was made in the last three years) to 0% by the time of the seventh anniversary. This is called ‘taper relief’ and the less time there is between the date of the gift and the date of your death, the more IHT the beneficiary has to pay.

So, what else could you do to reduce your inheritance tax bill?

Use your IHT annual exemption

There is another exemption that could be used to meet school fees.

According to the government’s website, you can give away £3,000 worth of gifts each tax year without this being added to the value of your estate. This is known as your ‘annual exemption’. You can carry any unused annual exemption forward to the next year too, but only for one year. There is a caveat that these gifts must not deprive you of your standard of living. Remember that’s £3,000 for grandad and £3,000 for grandma.

If you really want to start early, you might like to consider paying into your children’s ISAs if they have one as a tax-efficient way of generating funds for future school fees. You might think that paying into a grandchild’s Junior ISA (JISA) would be more appropriate; but a JISA cannot be accessed until the holder turns 18 and that would be too late to pay for their schooling .

The value of investments and the income from them can fall as well as rise and the investor may not get back the initial investment.

Gifting money out of your income

Whether it’s £3,000 or £6,000 a year, it won’t necessarily make enough of a dent on annual school fees, based on the figures we quoted earlier. But there is another exemption available. According to the same government web page, gifts out of your regular income also don’t count towards your inheritance tax liabilities. And gifts from income can align nicely with school fee payments, which come round regularly, like income does.

Consider a trust to reduce your inheritance tax

You could also think about setting up a trust, where the trustees release funds to pay the school fees. For example, the assets in a bare trust are taxed as if they belong to the child. According to the HMRC website, this could mean there’s no income tax liability generated by the investment, provided the income from the investment is less than the child’s personal allowance of £12,500.

Based on the government’s website, combining the £12,500 income tax allowance with the annual starting rate for savings allowance of £5,000 plus the personal savings allowance of £1,000, your grandchild could potentially withdraw £18,500 a year before having to pay tax.

There are various types of trust available, so you might like to ask a financial adviser about which would be most suitable for your family. Trusts can be difficult to unwind if you later find you’ve chosen the wrong one.

Get some help with the details

This is a potential golden opportunity to hit two birds with one stone by transferring wealth between generations in a way that could both benefit a child and reduce your family’s future tax bill. We’ve touched on a few ideas here, but there could be more options and what is right for you will depend on your individual circumstances

Tax rules are complicated and ever changing, so you might want to speak to an adviser who could help you put together the best possible plan for you and your family’s needs.

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