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Pinpoint school fees planning

An alternative strategy

It starts in the same way: Tony and Jane invest £120,000 in an international investment bond, which is divided into 12,000 individual segments of £10.

But then they transfer the bond into an absolute (bare) trust with Josh as the beneficiary and his parents, Mark and Alison, as co-trustees. This is to ensure continuity if anything happens to Tony and Jane.

It will be a potentially exempt transfer (PET) for inheritance tax purposes of £60,000 each - we will return to that later.

When fees become payable the trustees surrender individual segments. Now, as the bond is under a bare trust the gain is assessed on Josh who is a non-taxpayer, being a schoolboy without any earnings or investment income.

The gain is offset against his personal allowance – which is currently £11,500, but presumably will be higher in five years’ time. He also has his £5,000 starting rate for savings income band and the £1,000 personal savings allowance, both of which can be used to mop up international investment bond chargeable gains. This means that their £13,139 tax bill is avoided.

At age 18, Josh will be entitled to the remaining segments in the trust fund (if any) and can use them for his own purposes. He could then put them towards the cost of going to university, for example.

Death of a donor

What would happen if Tony or Jane died before Josh completed his education? The reassuring thing is that because the bond is held in trust, the money for the school fees will be there, whatever the position of the estate and its distribution.

If they died within seven years of the trust being established, the PET will fail and there will be a chargeable transfer registered against the death estate. If they had done no other estate planning, the effect of this on first death would be to use up £60,000 of the deceased’s nil rate band and reduce the available transferable nil rate band by 18.4615% (assuming a nil rate band of £325,000).

What if the parents are paying?

As we have seen, having generous grandparents and an absolute trust can work wonders when funding school fees.

But what if it is the parents who are meeting the bill? Using an absolute trust has no advantage, because any chargeable gains would be assessed on Mark and Alison because of the anti-avoidance parental settlement rules in section 629 of the Income Tax (Trading and Other Income) Act 2005.

Although conversely, the transfer will be exempt from inheritance tax because of the dispositions for maintenance of family provision in section 11 of the Inheritance Tax Act 1984.