Many parents value the standard of education offered by independent schools and will pay for that privilege. Planning for the fee payments can help. Even if the children do not go to an independent school, they could go to university. In this case, the children can end up with a huge outstanding student loan which could be a burden for many years. Planning for these costs can help avoid that situation.
The average fee for a boarding school is £10,753 a term (£32,259 a year) but if the child does not board and attends daily it is £6,043 a term (£18,129 a year).
For a child attending a day school, the average fee is £4,473 a term (£13,419 a year).
In addition, fees have increased considerably over the years and they increased by 3.5% on average last year (source: Independent Schools Council, annual census 2017).
The overall cost could exceed £300,000 (source: Education Advisers Ltd) – and that is just for one child. Without planning ahead the cost would be a huge drain on earned income or lead to a need for borrowing.
In some cases the grandparents can help out and this can be very tax efficient.
In this article, we demonstrate how an international investment bond and segmentation can be used to effectively fund education costs. Of course, the actual costs can vary and are unknown at the outset.
So to pinpoint the actual amount needed, and not draw unnecessary funds, it can be advantageous to use an international investment bond that can drill down the segments to a minimal level.
Case study 1
Tony and Jane Birmingham are both higher rate taxpayers and wish to make provision for the private education of their grandson, Joshua.
He is going to a very reasonably priced school as a day pupil and annual fees are currently £10,000. We will assume that they will rise by a modest 3% each year.
Josh starts secondary school in five years’ time and will continue there for seven years until age 18.
Tony and Jane expect to remain higher rate taxpayers and have £120,000 available for investment. Their adviser recommends that they take out an international investment bond, which is to be divided into 12,000 individual segments of £10.
If they simply invested in their own name and assuming an annual return of 4% each year (ignoring product charges), how would this strategy fare?
This table shows us the amounts required for school fees each year. As fees become payable, Tony and Jane cash in individual segments to cover that need, albeit with tax consequences.
When Josh reaches 18, there are 6,399 segments spare which can be used if the fees increase above the assumption used or growth is less than expected.
But the obvious thing to note is that although the fees are covered by the encashed segments, Tony and Jane will have a tax liability. They could pay this out of other resources or increase the number of segments encashed to produce a net amount equal to the fees payable.
At the end of year 5, for example, they would have to encash 982 segments as opposed to 892 to account for higher rate tax on the chargeable gain.
But is there a better way of doing this? Can they avoid the total tax bill of £13,139? The answer is yes, so let’s look at an alternative strategy.