With private school fees on the rise and the anticipated removal of VAT-exempt status in 2025, families across the UK are looking for ways to manage these increasing costs.
While there’s no direct tax relief for private education, there are several strategies that can reduce the financial burden, including intergenerational gifting, family businesses, and tax-efficient investments.
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Topics Discussed:
- Tax-efficient methods for managing private school fees.
- Using gifting, family businesses, and offshore bonds to reduce education costs.
2024 Average Private School Fees
Private school fees continue to rise year on year, with a significant increase projected following the removal of VAT exemption in 2025.
For 2024, the average annual cost for a day school is around £15,000 per child, while boarding schools cost over £39,000 per year.
Fees vary based on location and school type, and many schools offer different rates depending on the age group of the student.
These rising fees, combined with the potential for an additional 20% VAT charge in the near future, highlight the importance of strategic financial planning to manage education costs effectively.
Intergenerational Gifting – Leveraging Inheritance Tax Relief
One of the most effective ways to reduce the cost of private school fees is through intergenerational gifting.
Grandparents can contribute towards their grandchildren’s education while simultaneously reducing their estate’s value for inheritance tax (IHT) purposes.
The main tax advantage of this approach comes from the seven-year rule, which states that gifts will be exempt from IHT if the giver survives for seven years after making the gift.
Key Gifting Exemptions:
- Annual Gift Exemption: Grandparents (or other family members) can give up to £3,000 per year tax-free.
- Gifts from Surplus Income: Gifts made regularly from surplus income are also exempt from IHT, providing a useful way to fund school fees without incurring additional tax liabilities.
For larger gifts, consider setting up a Bare Trust.
In a Bare Trust, the grandchild is the beneficiary, and income generated from the trust can often be used to pay school fees without exceeding the child’s personal tax allowance.
This ensures any income is taxed at the grandchild’s lower rates, which can often result in little to no tax liability.
Family Businesses – Funding School Fees with Dividends
Setting up a family business/trust where the grandchildren are beneficiaries is another option to consider.
By distributing dividends to the grandchildren, you can fund private school fees tax-free, as long as these dividends remain within the grandchild’s annual tax-free personal allowance (£12,570 for the 2024/25 tax year).
It’s essential to structure this correctly to avoid tax traps.
Parents should not gift shares directly to their children, as this could trigger a tax charge.
Instead, grandparents or other relatives can set up the business, ensuring that the dividends fall under the child’s tax allowances.
This approach works well for those looking to manage private school fees in a way that maximises tax efficiency while keeping funds within the family.
Offshore Bonds – Tax-Deferred Gains for School Fees
Offshore bonds provide another tax-efficient route for covering school fees.
Parents or grandparents can invest a lump sum into an offshore bond and name themselves as trustees, with the children as beneficiaries.
These bonds can be split into smaller policy segments, allowing a portion to be encashed to pay for school fees each year.
The main tax advantage here is that when the bond is assigned to the child, the tax on the gain is payable by the child, who is likely to be within their personal tax allowance, meaning that in most cases no tax is payable.
Offshore bonds also provide flexibility as they can be managed to align with the changing financial needs of the family.
Using Pension Lump Sums – A Tax-Free Option for Older Parents
If you are 55 or older (rising to 57 from 2028), you can withdraw 25% of your pension as a tax-free lump sum.
This lump sum can be used to cover school fees without incurring any additional tax liabilities.
For parents or grandparents still working, this can be a particularly efficient way to fund education costs, especially if they are higher-rate taxpayers, as the pension withdrawal is tax-free.
Another strategy is to increase your mortgage to cover school fees, and then repay it using the tax-free pension lump sum when you reach 55.
This option allows you to cover education expenses while deferring the tax liability, but it’s essential to consult a financial adviser to ensure it makes sense in your broader financial plan.
Paying School Fees Upfront – Avoiding Tax on Investment Returns
For families with significant capital, paying school fees upfront in a lump sum can offer significant savings.
Many private schools allow you to pay fees in advance, investing the lump sum in low-risk investments.
Since private schools benefit from charitable status, these returns are often tax-free, offering a unique advantage.
If you were to make the same investments personally, the returns could be subject to income tax or capital gains tax, reducing their overall benefit.
By paying fees upfront, not only do you avoid these taxes, but you may also receive a discount from the school, helping to lower the overall cost.
Summary
With careful planning and the right strategies, families can reduce their tax liabilities and ease the financial burden of private education.
Whether it’s through intergenerational gifting, setting up a family business, investing in offshore bonds, or using pension savings, each approach offers opportunities to save on both taxes and school fees.
If you need expert advice on managing private school fees in the most tax-efficient way, contact us at Tax Expert.
Fill out our form here for any questions, give us a call at 01772 788200, or message us on our WhatsApp for out of office hours.
Kind regards,
Ilyas Patel