Paid post by Canada Life

Should you use a bond to pay for education?

Investment bonds are all about giving choices and being able to meet your client’s needs and goals.

Let us consider Stephen and Sarah who have been talking about sending their children to a local private school but, having realised that the average fee is £4,473 per term, know that paying for this privilege will be difficult. Stephen’s parents, John and Elizabeth, would like to give their two grandchildren, aged one and five, the best start in life.

John and Elizabeth have £500,000 to invest and, after considering various options, their professional adviser recommends an onshore bond. To ensure longevity he suggests that the two grandchildren are additional lives assured. In order to give as much flexibility as possible, the bond is set up with 500 individual policies each with a premium of £1,000 which at outset is transferred into a discretionary trust.

With a discretionary trust the trustees decide who should benefit and when, so the adviser suggests that Stephen and Sarah are appointed as additional trustees, as they are aware that the investment is intended for school fees. The transfer into the discretionary trust is a chargeable lifetime transfer but, as John and Elizabeth have not made any previous transfers, each can gift £325,000 before there is an immediate tax charge.

Therefore, as each is gifting just £250,000, there is no immediate inheritance tax charge. | September 2018 Under the bond, the trustees have the ability to take partial withdrawals each year of up to 5% of the amount invested; this can occur for at least 20 years without triggering an immediate tax liability. This means that £25,000 can be withdrawn each year and, if used properly, this facility can give access to regular or one-off payments with minimum administration.

The trustees set up termly withdrawals to coincide with the eldest grandchild starting private school in September. In the first year £13,419 is withdrawn but, as this is within the 5% tax-deferred allowance, there is no immediate tax liability. These withdrawals are distributions from the trust but, as no inheritance tax was payable when the trust was set-up, there will be no exit charge on the distributions under the relevant property regime.

If we assume that the school fees rise by a modest 3.5% each year, when the youngest grandchild starts private school in the fifth year of the bond, the trustees will require yearly withdrawals totalling £30,798. However, with the cumulative tax-deferred allowance the trustees can only continue to fund the school fees within this allowance until year ten.

In year ten the adviser informs them that, when the grandchildren are 14 and 10 and the school fees are £36,579, if they continue to take the withdrawals across all individual policies at the end of the policy year a chargeable gain of circa £8,292 will occur. The trustees are surprised to find out that John and Elizabeth would be liable to any tax. However the adviser confirms that, as both are basic rate taxpayers, even though a chargeable gain will occur, at the end of the policy year there will be no tax to pay. This is because when the chargeable gain is added to their income it doesn’t take them into the higher rate tax bracket, which means there is no further tax to pay, as an onshore bond carries a 20% tax credit.