Helping With School Fees Could Reduce IHT

In today’s evolving financial landscape, many families in the UK are seeking smart ways to manage their finances. One such avenue was covered by Interactive Investors today – grandparents can assist with school fees, not only providing support for their loved ones but also alleviating their future inheritance tax (IHT) burdens.

The Rising Cost of Private Education

Making the choice to send children to a private school is no small decision. With the Independent Schools Council reporting an average annual fee of £16,656 for a private day school, it’s clear that the costs are substantial. For parents who choose this route from secondary school up to the end of the sixth form, they could be looking at an impressive total of £116,592 per child.

Worryingly, this year, there’s been a fee increase of 5.6%, the largest since 2009. And for those aiming for top-tier institutions like Eton College, Harrow School, and Cheltenham Ladies College, the fees can touch around £50,000 a year.

Considering the weight of these costs, a higher-rate taxpayer with two children would need to earn about £55,000 annually, pre-tax, just to manage these fees. This can be daunting for many families.

The Rising Tide of Inheritance Tax

A related financial concern is inheritance tax. UK families are currently paying record amounts in IHT. To put it into perspective, IHT receipts amounted to a whopping £7.1 billion in 2022-23. This marks an increase of over 108% in just a decade. Fast forward to 2023, and within just five months (April to August), IHT receipts have climbed by £300 million compared to the same period in the previous year.

The way IHT works is that a 40% tax is levied on estates valued above the nil rate band (currently at £325,000). But if you’re leaving your family home to your descendants, this limit rises to £500,000. This means a married couple with a home can leave up to £1 million for their kids without the shadow of IHT.

However, with house prices soaring and the nil rate band frozen till 2028, it’s evident that an increasing number of families will face IHT concerns.

The Double Benefits of Generosity

There’s a simple logic to reducing the IHT your loved ones will owe: start distributing money that you won’t be needing. By doing so, you diminish the amount above the nil rate band, hence reducing the impending tax bill.

Supporting grandchildren with their school fees comes with a dual advantage. Firstly, it trims down the IHT bill, and secondly, grandparents can witness the direct positive impact of their wealth on their grandchildren’s lives.

Understanding IHT Gifting Rules

However, it’s essential to be aware that there are certain rules around gifting. While one can’t distribute infinite amounts freely, there are allowances in place that can be beneficial:

  • Gifts from Surplus Income: Especially pertinent for grandparents regularly assisting with school fees. The amount you can give away is unlimited, but it’s crucial to show that this money isn’t affecting your quality of life.
  • Annual Exemption: Every year, £3,000 can be gifted tax-free. For couples, this amount is doubled to £6,000. And if you missed using last year’s allowance, you can carry it forward once and combine it with gifts from surplus income.

Moreover, gifts beyond these allowances aren’t immediately taxable. These are seen as ‘potentially exempt transfers’. If you survive for seven years post making the gift, it’s fully out of your estate, attracting no IHT.

Considering Trust Funds

Establishing a trust can bring further tax advantages. By placing money into a discretionary trust, grandparents (or parents) can control the principal amount, while the interest generated can cover school fees. Notably, money in the trust up to £325,000 can be IHT-free if the donor survives for seven years post the gift. Also, the income by the trust is taxed based on the child’s tax rate, usually much lower, leading to potential savings.

Planning Ahead: A Family Affair

If IHT is looming large and you’re keen on supporting your grandchild’s education, starting discussions with your children is essential. This collaborative approach can ensure that the family is prepared, financially and otherwise, to meet educational costs, whether they arise now or in the future.

In conclusion, with the twin challenges of rising educational costs and IHT, smart financial planning is paramount. Leveraging gifting rules and trusts can ensure your family’s future is secure, and your money is utilized in the best possible way. Always consider seeking professional advice to navigate these intricate financial pathways.