Education costs in the UK have been steadily rising, making it increasingly difficult for parents to afford private schooling for their children. With fees increasing by almost 6% annually, families now face the daunting prospect of paying over £5,000 per term for a day school or £13,000 for boarding. Some schools even charge more than £50,000 a year.
To make matters worse, there is the threat of the government removing the VAT exemption on fee-paying schools, potentially leading to even higher prices. In light of these challenges, many middle-class parents are turning to their grandparents for financial support. However, it's crucial to consider the implications and potential tax liabilities before accepting this assistance.
Understanding Inheritance Tax
Inheritance tax is an important consideration when it comes to transferring funds for education purposes. In general, transfers made for the education of children under 18 or in full-time education are exempt from inheritance tax. However, there are certain details to keep in mind.
Transfers are only exempt from inheritance tax if they are made by the parent unless the child is not in the parent's care. This means that grandparents and other relatives generally do not benefit from the exemption, even if the transfer is made directly to the school. While this may seem limiting, there are ways to work around it.
Every individual has a £3,000 annual gifting limit without having to pay inheritance tax. Additionally, if this allowance has never been used before, it can be carried over in the first year, enabling grandparents to donate up to £12,000 in the first year and £6,000 in each succeeding year. While this may help reduce the costs of private education, it may not fully offset the annual expense. However, there are other possibilities for those who are able and willing to contribute more.
Exploring other gift options
If you survive for at least seven years after making a gift, you can give away a significant amount of money without incurring inheritance tax. This suggests that paying for higher education upfront, rather than in yearly instalments, may be advantageous. However, the amount of money within the £325,000 nil rate band at the time of your passing, as well as the value of your entire estate, will determine whether any transfers are liable to inheritance tax.
For example, imagine a set of grandparents who have enough savings to cover the school fees for their two grandchildren, totalling £222,000 over the course of their education. If their estate is worth £600,000 and includes a property they plan to leave to their direct descendants, and they have not made any other gifts during this time, they would not owe any inheritance tax even if they passed away within seven years. This is because their assets and gifts would be covered by their combined nil rate bands of £1 million.
A word of warning about gifts
For a gift to be a potentially exempt transfer (PET) and not create an immediate charge to inheritance tax, the value of the recipient's estate must increase, and the value of the donor’s estate must fall because of the gift. Therefore, if the value of the child’s estate (benefitting from the gift from the grandparent) does not increase, and the donor’s nil rate band has already been used, then the gift (unless covered by an exemption) is a chargeable lifetime transfer (CLT) and immediately chargeable to inheritance tax at the lifetime rate of 20%.
It's therefore very important to carefully consider these factors and seek professional advice to ensure the best course of action.
The Benefits of Creating a Trust
When grandparents want to make provision for school fees, they often create a trust for the grandchild. Establishing a trust has several tax benefits, as the trustees maintain control over how and when the assets are used. However, the child, as the ultimate owner of these assets, will be taxed based on their own income and capital gains tax allowances/exemptions.
Creating a trust offers an alternative solution for distributing funds. Paying for tuition on a monthly basis can help grandparents avoid inheritance tax on transfers, as long as they have enough disposable income. However, certain requirements must be met for these contributions to be excluded. By satisfying Section 21 criteria, these payments can be classified as typical expenditure out of income, ensuring the preservation of your loved ones' quality of life.
If you choose to employ this strategy, it is essential to maintain thorough records of your annual income and expenses, as the HM Revenue and Customs may request this information from your executor after your passing. Seeking the assistance of an experienced financial planner is highly recommended before deciding on the most tax-efficient way to support your family in the future, as mistakes in this area can have substantial consequences.
By utilising the annual gifting limit, establishing trusts, and paying tuition on a monthly basis, grandparents can help alleviate the burden of education costs while minimizing their tax liabilities. However, it is important to seek professional advice and carefully consider individual circumstances and goals.
Remember, every family's situation is unique, and it's essential to tailor financial planning to meet your specific needs. By taking the time to understand the available options and seeking expert guidance, grandparents can provide valuable support to their grandchildren's education while ensuring their own financial well-being.
We are happy to have an initial exploratory discussion to discuss this area of planning. Simply, pick up the phone and call us on 01746 712900 or send an email to info@matrixcaital.co.uk.