School fees planning - how to invest for and fund private school fees
Friday 2nd September, 2022
I am frequently asked by clients what the best way is to save for private school fees. This is a complex area, due to the generally limited time to build up funds before the savings will need to be drawn down upon, as well as the relatively high level of fee inflation. There is also a lot of confusion about the current level of private school fees.
In the article below, I have therefore taken the time to firstly review the current levels of school fees and the way they are paid. I will then look at the types of investments that should be used, as well as the most tax efficient investment wrappers to use. Lastly, I will also look at the options available to grandparents to help their family fund private school fees for the children.
As a financial adviser, I know that private schools are a real political hot-potato in the UK. There are those who regard paying for their child to get a private education as an obligation and the best thing they can do for their children’s future prospects. There are others who regard private school as unnecessary, elitist and a way of entrenching already glaring class inequality.
To be honest, in South Africa, where I grew up, it was regarded as very normal to send your child to a private school and there are many countries where that is the norm. I was therefore very surprised when I discovered what a divisive issue private schooling is in the UK.
I am the product of both a state and private school education and I can therefore see the merits in both arguments. There is a huge benefit to being taught in a class of 6 students, rather than a class of 30. The additional attention I received from teachers when I was in a private school made a huge difference to my understanding of subjects and therefore my performance. Furthermore, in a small class, there was nowhere to hide. In addition to this, when your father is forking out a large amount of money to send you to an exclusive school, there is a certain amount of pressure to succeed.
However, I also remember standing in the school quad and having one of my class mates casually point out that the private jet flying overhead was her father going to work, and she was not joking. There can be no doubt that the cost of private schooling pools together the children of the most wealthy, to the exclusion of the lower income earners. This means that wealthy children have access to more effective education and the best facilities and opportunities, naturally improving their chances for success in the future. These children also build social networks with those other well-off children around them, resulting in the “old school ties” phenomenon where those who have achieved the highest positions are likely to favour those from the same background and social group.
However, no matter how you look at it, the one thing we can all agree on is that private education is not cheap.
Day Fee (Boarding Schools)
Day Fee (Day Schools)
The table above is taken from the Independent Schools Council Census and Annual Report 2022 and represents average weighted fees per term. As I said, they are not cheap.
In addition to this, paying for private schooling is a commitment that can last 12 years. During that time inflation is likely to have a sizeable impact on the amount of money you are paying each term. The table below is also taken from the Independent Schools Council Census and Annual Report 2022 (it makes very interesting reading if you are thinking about private school) and it demonstrates that the average annual inflation of private school fees is between 4% – 5% per annum.
While that may not sound like much in the current inflationary environment, it is worth noting that these 4% - 5% rises occurred in a generally low inflation environment.
These high fees mean that for the majority of people, simply paying for their children to go to private school from net income alone is not an option.
The most sensible option is to build up savings to cover the bulk of the costs, and the sooner you start saving the better.
Which investments should I be saving into?
This is the question I am most often asked by clients and it is very important. The reason for this is the fairly high inflationary rate of private school fees. The reality is that most cash investments are not going to provide the returns that will allow the money being saved to retain its value in real terms.
It is therefore important that any savings are made into investments that have sufficient growth potential to maintain its buying power relative to inflation. This would involve investing into a portfolio of shares, bonds and property, which are all assets that have a history of generating inflation beating returns.
The down side of these investments, is that they can go up and down in value. This means that there is no guarantee about the returns you will receive, if any. The one way to mitigate this risk, is to ensure that the money is invested for as long as possible, before you need to drawdown on them. The reason for this is that over time, the volatility is smoothed out and the portfolio has greater potential to generate a positive return. This is demonstrated by the chart below, which shows that the probability of achieving a positive return increase the longer you hold the investment.
Source: Macrobond; MSCI World Equity Mid and MSCI Large Cap Total Return in GBP, 1 January 1972- July 2022
Therefore, it is really important to start saving for school fees as soon as possible, in order to increase the period the money is invested for and the chances of achieving a positive return.
Which tax wrapper should I be investing into?
Once again, this is really important. It is one thing to choose a portfolio capable of achieving high levels of growth. However, you also want to focus on making the investment as tax efficient as possible. There is no point in generating growth, just to watch a sizeable chunk of it vanish to the tax man. This simply increases the chance of you not achieving your goals.
Now, the government has actually provided us with a wonderful vehicle for building up school fees savings. This is the ISA.
The reason for the attractiveness of using an ISA for building up school fees is firstly that each person can save £20,000 per year into an ISA. This means that a couple can invest up to £40,000 per year into ISAs between them.
The funds within the ISA can be held either in cash or invested in shares, property and bonds. If you are likely to withdraw the funds within the next five years, then it is not advisable to invest the money into anything besides cash, as there is too much risk that the portfolio will suffer a loss and not have time to recover. However, if investing for over five years, it makes sense (as discussed above) to invest in more risky investments like shares and property.
All the growth and dividend generated within the ISA are tax free, and all withdrawals from the ISA are also tax free. This means that when it comes time to withdraw funds to pay school fees, there will be no need to worry about tax eating away a chunk of your investments.
If, for whatever reason, you don’t have your ISA allowance available, it still makes sense to invest in property, bond and share funds. The growth from these funds is generally subject to Capital Gains Tax (CGT) and by using your personal annual CGT allowance of £12,300, you can tax efficiently offset a substantial amount of the gain over time. Furthermore, any dividends can also potentially be offset against the annual dividend allowance of £2,000 per person. This means that, if managed properly, there can also be a substantial tax saving from non-ISA investment funds.
What about grandparents?
Many of my clients do send their children to private school and in about half the cases, their parents help with the fees.
The main benefit to grandparents of helping to fund private schooling, is that it can reduce their estate for Inheritance Tax purposes.
There are a number of ways that grandparents can help fund the school fees for grandchildren. I have listed these below:
Payments out of excess income
This involves making regular payments out of excess income to the children. This is a very useful option, as in many cases, gifts out of excess income can be exempt from Inheritance Tax.
The basic requirements to qualify for this exemption are:
- The gifts must be out of excess income, not capital
- The intention must be for the gift to be made regularly, at least once a year
- The gift must not have an affect on the standard of living of the donor
If all these requirements are met, then the gift out of excess income is immediately exempt for Inheritance Tax (IHT) purposes.
Small annual lump sums
We are all able to gift away up to £3,000 per annum out of capital and the gift is covered by our personal IHT allowance and is therefore exempt from IHT. This means that a couple could give up to £6,000 per year to their grandchildren, utilising their joint annual gifting allowances.
Gift a large lumpsum into trust
Quite often, a grandparent may wish to make a substantial gift to a child to fund their school fees. This gift is often made into a Bare Trust. By doing this, the funds are taxed against the position of the child and utilise the child’s individual tax allowances.
Provided the donor grandparent survives for 7 years after making the gift, then the gifted assets will fall outside of their estate for IHT purposes.
The major downside of this type of gift is that when the grandchild who is beneficiary of the trust turns 18, they can demand the funds held in the trust from the trustees.
A hybrid solution to paying school fees
From my experience, there are very few people who simply fund their children’s school fees with only income or only savings. The high level of costs, and the relatively short period of time to save before children start attending school, generally means that there is an “all-hands onboard approach” to paying the fees.
This can involve relying on a combination of school scholarships, income from grandparents, savings and their own income to get children through privately funded education. Some simply opt for a middle ground of paying for extra lessons through private tutors.
Saving to fund school fees is awkward, due to the time constraints involved. To demonstrate the problem, lets look at the costs for funding a single child attending a day school for their senior and sixth form schooling. This would entail 5 years of senior schooling and 2 years of sixth form schooling.
In calculating this, I have assumed an inflation rate of 4%.
Based on this calculation, your basic fee would be:
- £89,287.00 for senior school
- £43,558.00 for 6th form
- Total - £132,845
In order to save this amount by the time the child reaches senior level (assuming a growth rate of 4% per annum over 12 years) you would need to save about £9,000 per year. If you have two children, you are looking at a period of having to save almost double that.
This may seem achievable, particularly if you are a reasonably high earner. However, this does not take into consideration the costs if you decide to send your child to school for their junior years as well.
It is also important to remember that this figure only takes into account the school fees, and does not include the costs of school uniforms and the plethora of additional activities associated with private schooling.
As you can see, with private schooling, the costs simply stack up and the method for paying the fees is generally multi-pronged.
It is clear from the paragraphs above that investing to pay school fees is not as simple as it may at first appear. There are many traps and pitfalls along the way and it is very important to take financial advice in order to ensure that these are avoided. Taking steps to control risk and volatility and monitor growth, while also maximising tax efficiency can all help to make a difference.
If you would like to discuss this further, please book a free initial consultation with us through our website, emailing us, or by phoning on 01420 446777.