Lucy Brennan considers how parents and grandparents can pay for tuition fees tax efficiently

Savings plan

Parents can use an ISA to save for education, with the income (and capital gains if a shares ISA) rolling up tax free. Over the period from birth to a child starting school a substantial amount can build up, with the current ISA allowance at £5,340 for a cash ISA and £10,680 a for cash and shares ISA. Using both parents’ ISA allowance will add to the tax efficiency of the savings.

However, parents should be aware that the simple solution of putting an income generating asset (such as a cash) in their child’s name, while saving for a child’s future, will not necessarily save income tax on the income generated. Where parents transfer income generating assets to their children, income over £100 is taxed to the parents and the child’s personal allowance remains unused.

For university fees, parents should consider the use of children’s trust funds and junior ISAs. Income and capital gains in these funds again roll up tax free and parents can invest up to £3,600 per annum for the benefit of their children. If the maximum is put in every year through to the child’s 18th birthday (when funds can be taken out of the account) that is £64,800 plus the tax-free rolled up income. This will both pay for university and perhaps help children on the property ladder once they have finished their degree.

There are ways to assist children, save inheritance tax and not potentially subject income to an income tax charge when assets are transferred to children. If grandparents wish to consider funding their grandchildren’s education it can be very tax efficient, especially as capital can move down two generations, saving both inheritance tax on the grandparents’ and parents’ deaths. This could be done by direct payment of all or part of the school or university fees each year.

There is an annual allowance of £3,000 per annum for gifts that an individual can make. If a prior year allowance is not used this can be carried forward and so £6,000 may be gifted in the first year. This may not seem a lot, but through school and university this would remove £63,000 from an individual’s estate at death for inheritance tax purposes in initial capital alone, plus the income generated by the capital over say 21 years.
For example that could be £79k if £3,000 is invested at an annual net of tax return of two per cent (and of course most people are hoping for a higher return of that). That is an inheritance tax saving of £31,600 at 40 per cent and in the meantime were any of that sum to be invested (in say the pre-school years) the income on the investment is likely to be income tax free due to the child’s personal allowance.

Income source

The normal expenditure out of income exemption may also be used tax efficiently for grandparents to pay for school fees. Under this exemption, if an individual is paying an expense that can be considered normal expenditure (i.e. habitual and regular payments with a pattern), out of income and not capital that leaves the individual making the payments with enough income to maintain their normal standard of living, these payments will not be considered a gift for inheritance tax purposes.
The position must be reviewed when income sources change, for example on retirement, to ensure that payments are still from income and not capital and sufficient income remains to maintain the individual’s living standards. If possible, records of income and expenditure should be kept to demonstrate that the exemption applies.
If the exemption does not apply, then such gifts during an individual’s lifetime will be considered a potentially exempt transfer, chargeable to inheritance tax should the individual die within seven years of a gift (although a discounted rate of inheritance tax is applicable in years four to seven).

Another way to pay for school or university fees is the transfer of an income generating asset to grandchildren. This could be in the form of, for example, a share portfolio. Again a gift from a grandparent means that limited, if any, income tax is payable on income arising from the asset due to the child’s personal allowance. The child then has the income from that asset to help pay for their school or university education.
The gift of the asset is again a potentially exempt transfer with no inheritance tax if the transferor survives seven years from making the gift. However, careful consideration should be made to the asset that is transferred. If a grandparent expects to survive the seven years after the transfer then an asset on which inheritance tax is payable would be preferable for the transfer. As an example, while shares in a family trading company may seem to be an ideal gift, there may be no inheritance tax saving as these shares may gain business property relief on death and have no inheritance tax payable on them.

Early start

A final area to consider when saving for a child’s future education is a pension. With tax relief on monies put into a pension and a tax-free lump sum of up to 25 per cent available for withdrawal at 55, putting money into a fund to pay for university fees or to pay off a loan taken out for school fees may be an attractive option for parents and grandparents.

A concern in all of the above is access of children to income and capital that they may spend on items instead of their education. While monies invested into a child’s ISA or child trust fund can not be accessed by the child until they are 18, direct investments to a child can be. The setting up of a trust (whether a discretionary or bare trust) for the child until they reach 18 can elevate this concern.

The essential thing to remember is that it is never too early to invest in your child or grandchild’s education. Regular saving from their birth can start to set up your child for the rest of their education through to the end of university.

Lucy Brennan is a partner in the private wealth team at Saffery Champness