Paying the grandkids’ school fees could generate a shock IHT bill

The majority of families receive help when paying private school fees – 65% according to think-tank Civitas. Of this group, 30% have received a gift from family or friends, and 13% a loan from loved ones.

It is hardly surprising when you consider the cost. Data from the Independent Schools Council (ISC) shows the average termly fee for a day school was £7,382 in January 2025, up 23% compared to a year ago.

Costs soared at the start of the year as the government’s new VAT policy kicked in, forcing even more families to turn to the Bank of Grandma and Grandad. Data from wealth manager Saltus suggests an additional 7% of parents are calling on their own parents or other family and friends for help as a result of the policy.

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While affluent family members may want to help out by giving away some of their wealth during their lifetime, it is not always a simple solution. Depending on how the school fees are paid, there could be inheritance tax implications.

How does inheritance tax work?

Inheritance tax rules are complex, but the general gist is that everyone can pass on an estate worth £325,000 before tax is due, with an additional £175,000 allowance in some cases, if you leave the family home to direct descendants.

Beyond this, most assets are subject to inheritance tax at a rate of 40%.

To prevent people from simply giving their wealth away during their lifetime, the government has introduced strict rules around gift giving. You can give away as much of your wealth as you like during your lifetime but, if you don’t outlive the gift by seven years, there will be a tax bill.

In many cases, school fees paid by grandparents are classified as a gift for inheritance tax purposes, meaning you could be slapped with a shock bill if they suddenly pass away. With this in mind it is worth getting clued up on the rules – as there are strategies you can take to manage this liability.

The exception: gifts out of normal expenditure

Anyone can give up to £3,000 of their assets to loved ones each tax year without that sum becoming liable for IHT. If you didn’t use the allowance last year, you can combine it and pass on £6,000.

You can also make gifts out of any excess regular income without the risk of a future inheritance tax bill. Gifts from surplus income are not subject to inheritance tax, no matter how large the amount.

To qualify, the gift giver must be able to prove the gift has come from income rather than capital. What’s more, the gift must not impact the giver’s quality of life. If you are a grandparent looking to help out with private school fees, this is probably your best bet.

By making regular payments that cover the fees (for example, out of your pension income), you can avoid the risk of inheritance tax entirely, provided you are able to prove the money came from normal expenditure.

Meanwhile, if you were to raid your savings account to pay the fees in one lump sum, that money would be classified as having come from capital. As such, it would be considered a “potentially-exempt transfer”, meaning you would need to outlive the gift by seven years to avoid inheritance tax (assuming the rest of your estate exceeds the £325,000 tax-free allowance).

Using your pension income to pay school fees

Unused pension pots aren’t currently subject to inheritance tax, but this will change from April 2027 after changes announced in last year’s Autumn Budget. This has prompted some savers to give away more of their wealth in their lifetime. Paying school fees could be one way of doing this.

The tax changes on pensions have significant implications, because beneficiaries who inherit a pension could face double taxation. As well as paying income tax on any withdrawals (charged at their marginal rate), they will now face inheritance tax too. As we explain in a separate piece, this can result in an effective tax rate of 52% for basic-rate taxpayers, 64% for higher-rate taxpayers, and 67% for additional-rate taxpayers.

“One of the things we’re starting to look at – and we’re having this discussion with grandparents thinking about school fees – is if we take money from the pension and pay tax on it, that is seen as earned income,” said Katie Ridlands, senior partner at St James’s Place.

“Therefore, if their other income sources cover their expenditure, anything they’re putting down at this point (which perhaps they had earmarked as being the inheritance for the next generation), can be given as a gift out of normal expenditure.

“And the beauty is that, so long as the gifting amount is similar, the beneficiaries do not have to be the same or receive the same amount every year. You can vary it. So if you’ve got several grandchildren at different stages of their education, you can gift the money accordingly.”

If you are making gifts out of normal expenditure, it is important to keep detailed records as evidence. The executors or administrators of your estate will need this information when completing HMRC’s IHT403 form as part of the inheritance tax process.