The purpose of savings is clear; it's to help ensure you can afford to pay for school fees as they fall due. The very fact that you know you have possibly years of regular bills to pay is in a way a help, as you can make a good estimate as to what they will amount to and you can start to save now.
The earlier you start the save the easier it will be to build up substantial savings balances, and when you consider things like paying for higher education, if you start saving when your children are born you usually have a full 18 years, or more than 200 months, to build a fund to cover the costs. Paying just 30 pounds a month into a non-interest bearing account would build a fund of more than £4,000 by the time your child goes to University.
The purpose of this section is to explain some of the most useful ways of saving. It is not intended to remove the need for you to take proper financial advice from a registered financial advisor.
You should start by working out how much you need and when. Most advice just says "save as much as you can as early as you can". This isn't very helpful and we strongly suggest you either set up a month by month spreadsheet to estimate your likely outgoings on education over the next 10 or 15 years or use the Allabout Modeller ™ to do it for you. Given how much you could be spending on private education, we do believe our subscription is a small price to pay to have a degree of certainty about this whole area.
There are a bewildering number of ways to save and products to invest in. We suggest you gain at least a basic understanding of all options before making your choices.
Child Trust Funds
This is a government scheme whereby every child born on or after 1 September receives an investment voucher. The current voucher is worth £250. The child will receive another voucher when they reach seven years old – this is paid directly into the child's account. The voucher must be invested in an account that cannot be accessed or withdrawn from until the child is 18. This means that whilst the Child Trust Fund (CTF) scheme can be used to help fund higher or University education, it doesn't help pay school fees directly.
Anyone, family and friend, can top up a child's CTF account by up to £1200 in any single tax year (that's £1200 in total, not per person making a payment). Neither the parents nor the child will pay any tax on income or gains in the account. To be eligible your child must be resident in the UK and their parents or guardians must receive Child Benefit for them. Receipt of a CTF voucher will not affect any other tax credits or benefits received by the parents.
As you might expect there is a wealth of information on these accounts, including sites that list approved suppliers of these accounts. We've included some links to a few of the better informative sites in our Useful Links page.
The most obvious and risk free thing to do is to make a standing order payment every month to a standalone savings account. If you or your partner is a lower rate or non-tax payer make sure the account is in their name so you pay as little tax as possible.
Individual Savings Accounts or ISAs
ISAs are special savings accounts whereby any growth or returns on investments held within an ISA are tax-free. You'll sometimes hear the accounts referred to as a "tax free wrapper".
Investments, including savings accounts, held outside of ISAs usually attract either income or capital gains tax, so you should always consider making full use of your ISA allowance. You may invest up to £7,200 per tax year, and are unable to carry unused allowances forwards or backwards over tax years.
Once you withdraw funds from an ISA you can't then put money back in – you can't re-use your tax allowance. You can however usually transfer money between ISA accounts and providers. You need to just be careful how you do it; you must transfer ISA accounts, not close one account and open a new one – this would be the same as withdrawing your funds and so would be the end of that specific year's allowance. Just check the small print of both your existing and new ISA account providers first to confirm they allow account transfers.
In the 2008 budget the government abolished the rules surrounding mini and maxi ISAs, so we won't cover them here. There are now just two different types of ISA, a Cash and a Stocks & Shares ("S&S") ISA. Clearly this refers to the type of investment you hold in each one.
Cash ISAs: you may only invest up to half your allowance, £3,600 in a cash ISA in any one tax year, the balance can be invested in an S&S account. You may subsequently transfer any cash into an S&S account, but you cannot switch money from S&S back into cash. As with any cash savings accounts there are a variety of different rates on offer, so it pays to shop around. As with standard savings deals be on the lookout for both special rates and terms such as introductory bonuses that can appear attractive but that are attached to accounts that then pay very unattractive rates once the introductory period is over. There is nothing wrong with these accounts, just be sure to keep an eye on the detailed terms of your account and to be ready to move your money should the rates become uncompetitive.
We have included some useful links to sites with ISA savings rates in our Useful Links page.
S&S ISA; you may invest your whole allowance into a stocks and shares ISA if you wish. A range of non cash assets such as stocks, shares, unit trusts, open ended investment companies and investment trusts can be held within an S&S ISA. We'll cover what some of these investments are in the separate link on What to invest in.
Via your pension
A new feature in the pensions legislation introduced in 2006 means that tax relief could help you pay your children's school fees. As before, you get tax relief on money paid into pensions; so you can get up to 40% tax relief on your investments. This means that instead of having to invest cash that has been taxed, you can invest, via your pension fund, tax-free money.
Previously you couldn't access your pension pot until retirement, and you pay tax on withdrawals from the pot. The new laws now allow you to withdraw up to 25% of your pension fund as a tax free lump sum when you reach 50 (it will be 55 after 2010) so you could avoid ever paying tax on a quarter of your pension fund. There are no restrictions on how the money can be spent, so you could use the amount to pay for those school fees
The savings are obvious - you avoid tax on the lump sum. If you had a £1,000,000 pension fund and you withdrew a quarter of it you'd avoid tax of up to £100,000 (40% of £250,000). That's a few years of any school fees!
Remember that taking money out of your pension will reduce the size of your pension fund and the size of your subsequent pension. Remember also that pension savings are locked away until retirement, whereas you can access regular savings accounts (some of which will charge you penalties if you withdraw funds ahead of schedule).
Other issues to think about and talk through with a financial advisor include:
Reallocating your assets and investments to make full use of lower rate tax allowances and thresholds.
- Non-UK residents investing offshore
- Making full use of all possible capital gains allowances
- Spreading your investments to reduce the risk of any of them underperforming
Trust planning can be useful for grandparents who wish to make provision for school fees and achieve Inheritance Tax benefits at the same time.
Trusts offer the benefit of transferring the tax liability on future income and capital gains to the children to utilise their personal annual allowances. Chargeable gains on life policies may also be re-assigned, which could avoid a higher rate tax charge. It is important to take advice on the correct trust arrangements for the investments held.
It is also possible in some circumstances to transfer an existing capital gain to the trust, avoiding the need to settle the tax bill on transfer. The capital gain will later be assessed against the beneficiaries or the trustees; however indexation relief will be lost.
Advice to parents will need to take account of the parental settlement rules governing the taxation of gifts to children.
There are basically two types of trust; one in which the children have a right to any income arising from the trust and also own the capital, the other where the distribution of capital and income is at the discretion of the trustees. Accumulation & Maintenance Trusts offer both of the above.
Parental settlement rules assess the income arising from trust assets as the parent's income, which makes it more difficult to benefit from trust planning. However there is the opportunity to gain immediate benefit through making payment directly to the school. "Composite fees" qualify as a disposition for the benefit of a family member and as such the capital is immediately removed from the estate with a potential IHT saving. There are however drawbacks in terms of future potential growth, so advice should be sought in this area.
Trust planning is not suitable in every situation. If you would like advice in this area contact a specialist adviser.
Remortgaging and Loans
If you have equity in your house, you could take out a new or top up mortgage to receive all or some of that equity in cash. This cash can then be specially invested or set aside to pay for fees later on.
If you are able to remortgage your house whilst keeping the same size mortgage but paying less for it, this could free up cash each month to either save or directly pay the fees. Actually, whether you have schools fees to pay or not, it's always a good idea to be paying as little as possible for your mortgage, so check your mortgage deal on a regular basis to ensure you aren't paying too much.
Another route is to take out a loan. You can get secured or unsecured loans. Secured loans, where you put up collateral to protect the lender against you defaulting are often cheaper than unsecured loans. The most common secured loan is obviously a mortgage, but many people have loans secured against other assets. Remember that the whole point of a secured loan is that if you fail to make the repayments you could end up losing the asset you took the loan out against; missing your mortgage payments could result in your house being repossessed. Unsecured loans, overdrafts and such like are often materially more expensive than secured loans.
Gifts, Grandparents and Inheritance tax
There are specific yearly limits on how much money (or valuable assets) you are able to give away without incurring tax. These limits, which exclude charitable donations, can be found by asking your financial advisor or online at HRMC.gov.uk. From the same sources you can also check the latest rules surrounding how much your estate can be worth on your death before you incur inheritance tax, or death duties.
One way of minimizing inheritance tax that is very popular with grandparents is to pay for or contribute to their grandchildren's school fees. This will be viewed as a gift, but so long as the amount is below the annual gift limit this arrangement can be a very effective way of gifting cash through the generations of your family, and keeping your hard earned cash out of the hands of the tax man.