Tax-efficient ways to pay school fees

A survey this week suggests one in six of those with children in private schools rely on grandparents to pay the bills. This seems remarkably low with the total cost of a private education at day school for even two children coming in at £400,000, almost everyone I know with kids in private school is hitting their parents for vast sums every term. I wasn't surprised to find research from YouGov showing it is closer to one in four.

What if you are one of those unlucky grandparents whose children haven't used their own education to make enough money to pay for their own children? How can you transfer the cash in the most tax-efficient manner without making your own retirement miserable? First, make sure your children are using their Isa allowances properly. If they use the full allowance every year, and make the money grow at 5% a year, they will have £200,000 to play with. Next, think about inheritance tax. You can hand over £3,000 a year with no strings attached. But as long as the money comes out of your income, you can give regular (and as large as you like) gifts towards school fees you can even make it clear that the gifts are regular by paying them straight to the school. If you make the payments out of capital, they will be counted as potentially exempt transfers for inheritance tax purposes ie, there will be tax to pay if you don't live for seven years after the transfer.

So what's the best way to deal with a lump sum gift? You could, say the private bankers at Duncan Lawrie, consider a trust fund. We are against trusts at the moment for the simple reason that their benefits have been eroded to the point that they can be more trouble than they are worth. There isn't, for example, an obvious tax advantage to putting money into a trust, in that it will still take seven years for the money to leave your estate for inheritance tax purposes.

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But that said, there may still be good reason to use a trust for school fees: as Duncan Lawrie points out, divorce is common these days and any money you might give is at risk from matrimonial disputes if you don't ring-fence it. A bare trust does that. A bare trust is also taxed at the beneficiaries tax rate that means that you can use the grandchildren's income and capital gains tax allowances up each year. Then, if there is anything left when the children turn 18, they are entitled to take it, but "it is possible to design the trust so that school fees have reduced the assets to around zero by that stage". Finally before you transfer all your money note that UK private schools offer around £620m every year in scholarships and bursaries. A little of that would help nicely.