For many families, choosing the right school or university for their children is a difficult decision. Once this decision is made, or perhaps even before, families should think as well about how they will fund that education.
Fees in the UK can be considerable, so it is important for families to consider effective and tax-efficient ways to provide for their children’s education. The options available depend on whether a family is based in the UK or outside it. For those in the latter category, it is often best to keep things simple; however for those living in the UK there is more scope for greater planning.
Families based outside of the UK
Who can study here?
Anyone between the ages of 4 and 17 who wants to come to the UK to study must, unless they hold a full UK or European Economic Area passport, apply for the relevant visa to do so.
To be eligible, the student must have an unconditional offer with a qualified education provider, of which there are currently over 1,500 in the UK, licensed by UK Visas and Immigration. However, there are restrictions on the type of school which entrants to the UK can attend. Between the ages of 4 and 15, a student is permitted to study only at an independent fee-paying school. 16 and 17 year olds will be able to study at a publicly-funded college of further education, provided it is able to charge for international students.
The visa must be obtained before the student arrives in the UK. Then, provided the course of study lasts for more than six months, the student can arrive up to one month before the course starts.
Families often have overseas trusts or foundations in place; however, using these structures to fund their children’s school fees and other living expenses may be inadvisable.
This is because a child in the UK receiving a benefit from the overseas trust or foundation could give rise to a UK tax charge for the child. The trust or foundation may have been established long before school fees were considered and a UK tax charge can be both unexpected and administratively burdensome. Furthermore, legal advice on how to pay fees and expenses from these structures may be complex and therefore expensive.
The reality with funding school fees from overseas is that simplicity is often the best policy and the best way is for parents to fund the fees directly themselves. This is simpler, unlikely to involve legal fees and often for very wealthy families can be funded directly out of income.
Where a gift is made by a parent to a child in the UK, it is sensible to make those gifts to the child’s non-UK bank account, so as to prevent any argument that the gift was made in the UK, and therefore potentially subject to UK inheritance tax (“IHT”) in future.
Where a UK resident but non-domiciled parent, who pays tax on the remittance basis, wishes to fund a child through UK university, they should again complete any gifts to their child outside the UK, so as to avoid a remittance by the parent of foreign income or gains to the UK. Note that the child must be over 18, otherwise it will be treated as a remittance by the parent even if the child brings the money to the UK.
Some students coming to study in the UK may have wealth in their own right, particularly once they reach university age. In those circumstances, they should be careful which money they bring to the UK to fund their expenses. Foreign income and gains brought to the UK may suffer UK tax. It may be sensible to segregate non-UK bank accounts, keeping income, gains and “clean capital” separate.
Families based in the UK
Gifts from parent for education
There is a specific provision in the Inheritance Tax Act which says that certain gifts made by a parent for the “maintenance, education or training” of their child, are not subject to IHT. This is a valuable exemption for many parents.
However, in some circumstances, for example where unmarried couples or grandparents want to provide for a child’s education, some more thought is needed to achieve this in a tax-efficient way.
Funding from ‘normal expenditure’
Gifts which are treated as normal expenditure out of the donor’s income are exempt from IHT. If this exemption applies, payments will be exempt from IHT and there is no statutory limit on the amount that can be claimed. To apply, the transfers must:
- be regular in nature;
- be made out of the donor’s income; and
- leave the donor with enough income to maintain his usual standard of living.
It is important that the donor keeps a good record of his income, expenditure and intentions regarding payment of school fees, to present to HMRC, if necessary.
Funding using trusts
In the past, it has been common (particularly for grandparents) to establish trusts in order to fund children’s education. Before 2006, this was often
done through an “accumulation and maintenance trust”, which enjoyed a favoured IHT status. Since then, trusts of the IHT allowance, or “nil rate band”
(currently £325,000) have been common, as this would avoid IHT charges on creation and in future if managed appropriately. After seven years the same person could create a new trust with the same tax benefits.
Now however, a prospective change in the law means that a person should think much more carefully before establishing
a trust of this type. From 6 June 2014, everyone will have one “settlement nil rate band”, and anyone who creates a trust must decide what proportion of this is to be allocated to the trust. Once wholly allocated, it will not be replenished after seven years, meaning that any future trusts created will suffer IHT when money is distributed from their trust and on 10 year anniversaries.
So, anyone who now sets up a trust to provide for school fees must be aware that this will affect their scope for other planning in future.
Bare trust for minor children
Instead, another simpler solution is available, namely a bare trust. In many respects, bare trusts for children under 18 are like the trusts outlined above, in that they have trustees who look after assets on the child’s behalf and who – because the beneficiary is under 18 - have the same wide duties and powers.
However, there are certain tax advantages. If a parent sets up the bare trust, they will pay income tax themselves as though any income arising belongs to them. If, however, other family members (e.g. grandparents) set up the bare trust, the child is taxed as though the income belongs to him. If this income is less than the child’s personal allowance (currently £10,000) and the child has no other income, no income tax will be payable.
A bare trust is not classed as a “settlement” for IHT purposes, but rather as an outright gift to the child. This means that, if the donor survives seven years from the date of making the gift, no IHT will be payable.
Bare trusts are easy to administer, easy to understand and have low running costs. They also offer the same protection as normal trusts. The child is absolutely entitled to the assets, but before the child reaches 18, he cannot give “good receipt” to the trustees, which means that he cannot direct them to transfer assets or income to him. The trustees will therefore retain control of the trust fund.
When the beneficiary reaches 18, he is then able to request control of the assets. However, by that stage the trustees will have paid school fees for a number of years, so the majority of the money should have been spent.
An option for UK and non-UK parents alike is to pay school fees upfront in advance, often referred to as a “composition fee scheme”. Parents will of course have to be sure that they like the school enough to commit their child to studying there for a long period of time, but schools do offer reduced fees if parents are willing to pay in advance. Paying in this way has the benefit of transferring the value out of the parent’s estate at an early stage.