School Fees
From UK Independent Schools
A first-class education is one of the most valuable gifts that parents or grandparents can give to children.
Wherever you choose to do so in the private sector, it is also one of the biggest financial commitments a family can make. Costs are substantial, have tended to rise faster than other forms of inflation in the past, and are likely to continue doing so in future.
For example, if you take fairly typical boys' preparatory school fees of £2,400 a term and assume inflation of 6 per cent per annum, then the total cost over 16 years of sending one boy to prep and senior school, followed by university, is almost f300,000 (or f297,500 to be precise).
Since the abolition of student grants, funding education has become an issue for everyone who hopes their children or grandchildren will attend university. Indeed, those with children in private sector schools sometimes wryly remark that one of the advantages of paying fees is that it prepares you for the cost of university.The average graduate now begins working life with f 12,500 of debts - and the average graduate salary is just f14,000 before tax.
The good news is that inflation over the years of education plays a major part in creating that daunting total of about £300,000 to fund prep and senior school, followed by university. So the cost in today's money would be substantially IowecThis raises the important point that by planning to fund education and implementing a savings strategy now, time will be on your side, instead of working against you. In other words, investment growth may match or exceed inflation over the period and help you meet costs as they arise.
Fortunately, various tax reliefs remain available which can help families fund education. While it is never too late to benefit from some of them, the sooner you start to plan how you are going to pay for this commitment which may, depending on the age of your child or children, stretch out over a decade and a half or more - the greater your choice will be about how you do so.
BENEFITS OF PLANNING
A thorough review of your income and assets, both current and anticipated, is an obvious first step. You may be pleasantly surprised at how money you had thought was "locked up" in, for example, with-profits endowments or half-forgotten saving schemes can be utilised or borrowed against at preferential rates. Investing an hour and a half in a thorough fact-find by an independent financial adviser could pay dividends immediately and many years hence.
It may also be possible to'kill two birds with one stone' by rearranging assets to minimise liabilities to income tax and inheritance tax (IHT) while also planning to meet school or university fees.Grandparents often want to help with these costs and a specialist adviser can suggest the most effective ways for them to do so, making maximum use of tax reliefs and exemptions.
Similarly many married couples fail to utilise a non-earning spouse's personal allowance to f4,615 annual tax-free income, for example, and many families living in homes worth more than f255,000 - the current threshold for IHT-fail to make any plans to avoid this fixed 40 per cent tax. These are, however, complex areas where specialist advice, specific to your individual and family circumstances, is likely to prove particularly valuable. Questions to ask your adviser are set out in chapter 5.
INDEPENDENT ADVICE
Because of its long-term nature and the substantial sums involved, planning to fund education should be an ongoing advisory process.This should take account of all your family circumstances including, for example, whether or not there is adequate financial protection in place for the family breadwinner or breadwinners. The last thing you want is for parental misfortune to force a child's relocation to another school. Many people are pleasantly surprised just how little it costs to buy f100,000 of financial protection notjust against the risk of the policyholder's death but also against the risk of them suffering - but surviving - a serious illness. At present, a 45-year-old man could buy that amount of cover against both risks for less than f70 a month over 20 years.
With such a wide variety of factors - including insurance and investments - to consider it is important to understand the difference between independent financial advisers (IFAs) and tied representatives of one company.
As their name suggests, tied reps can only sell the financial products of a single company - be it an insurer fund manager or bank - whether or not these happen to be the best available or the most suitable for your individual needs. For example, all the Big Four high street banks' branch managers are tied representatives. By contrast, independent financial
Financial advisers are required to consider the whole of a highly competitive marketplace before making their recommendations about the best and most appropriate options for you. By choosing private education,you have already decided you want more than the 'off the peg' option and a financial plan tailored to your individual needs may prove the best way to fund that.
GETTING STARTED
Most homeowners are very pleased they took on the substantial commitment of house purchase - and funding education is a financial project of similar scale, except you are likely to have about a decade less in which to generate the cash. Indeed, one option to discuss with your adviser to immediately improve cash flow to fund short-term school fees is remortgaging. Most people still pay lenders' standard variable rates whereas discounted, fixed and offset deals may all cut monthly bills substantially,freeing up funds to be used elsewhere.
While it is never too late to benefit from specialist advice, the sooner you start a disciplined and methodical approach to financial planning, the more choice you will have about how to achieve your objectives.
That is why the next three chapters are set out in relation to how much time there is before fees need to be paid. Chapter 2 describes investments suitable for 10 or more years; chapter 3 assesses the options over five or more years; and chapter 4 deals with immediate needs. Of course, where there are two or more children of different ages, then several strategies may be relevant to the same family. This guide is not intended as a substitute for financial advice but, instead, to suggest areas that may be worth consideration with your independent financial adviser. Before plunging into the specifics of individual investments and tax shelters, it is worth making the simple point that, rather like doing a little homework regularly instead of trying to catch up on the night before an exam, the easiest way to improve your chances of funding education successfully is to start planning sooner rather than later.
While it is never too late to benefit from specialist advice, the sooner you start a disciplined and methodical approach to financial planning, the more choice you will have about how to achieve your objectives.
That is why the next three chapters are set out in relation to how much time there is before fees need to be paid. Chapter 2 describes investments suitable for 10 or more years; chapter 3 assesses the options over five or more years; and chapter 4 deals with immediate needs. Of course, where there are two or more children of different ages, then several strategies may be relevant to the same family. This guide is not intended as a substitute for financial advice but, instead, to suggest areas that may be worth consideration with your independent financial adviser. Before plunging into the specifics of individual investments and tax shelters, it is worth making the simple point that, rather like doing a little homework regularly instead of trying to catch up on the night before an exam, the easiest way to improve your chances of funding education successfully is to start planning sooner rather than later.
LONG TERM FUNDING
MINIMISING RISK
Unfortunately, shares and bonds traded on the stock market may fall in value without warning.This volatility means that direct investments in stock market assets is a risky strategy for people funding education who need to be confident that cash will be available on fixed dates in the future. One solution to that conundrum - how to gain access to stock market assets' historic tendency to produce higher returns than deposits, while minimising exposure to risk - is the with-profits endowment which, provided it is capable of running for 10 or more years, can pay out a taxfree lump sum.
The fundamental idea is to smooth out the peaks and troughs of the stock market by dividing returns to policyholders into two types of bonus.Annual bonuses,as their name suggests, are declared each year and, once declared, cannot be withdrawn;thus creating an upward-only ratchet effect in values for policyholders.lt is worth pointing out that this is absent for shareholders and other direct investors in the stock market who cannot spend today profits that were available three years ago but which have disappeared with falling share prices. Finally,when the with-profits endowment matures, a terminal bonus may be declared to distribute to policyholders any extra returns which may have been achieved during the period of investment. As mentioned earlier, the maturity value is entirely tax-free - although basic rate tax is deducted from the underlying assets of the fund.
WHAT ABOUT FALLING RETURNS?
Interest rates and inflation have fallen in recent years to near their lowest levels in half a century and this has been reflected in reduced investment returns. However, it would be unrealistic to expect the same nominal or headline rates of return to be achieved today as when inflation was in double digits. Instead, it is more sensible to look for a real rate of return that is, a nominal or headline return which is higher than the rate of inflation - to ensure that the purchasing power of your money is growing. It is equally important for people funding education that this should be achieved with moderate or low risk.
With-profits endowments have attracted considerable criticism in recent years as maturity values have fallen.5o it is, perhaps, surprising to find that 10-year plans maturing in 2003 continued to produce positive returns, sometimes handsomely so, despite dramatic stock market setbacks. Money Management, the magazine for independent financial advisers, surveyed 48 life companies' 10 year with-profits endowments maturing as far back as 1974. Assuming investments - sometimes called premiums - of f50 a month, or a total of £6,000 over the life of the endowment - the average return in 2003 was £7,713 tax-free. Not bad for a low-risk investment with life assurance thrown into the bargain - and life cover is a particularly valuable consideration for people funding education.
THE BEST AND THE WORST
Better still, the top performing 10 year with-progts endowment maturing in 2003 turned total investments of £6,000 into £9,489 tax-free; a profit of more than 50 per cent. Against that, the worst-performer in Money Management's survey delivered £6,614- or a profit ofjust over 10 per cent during the decade of £50 a month premiums.The important point here is that all these with-profits endowments delivered profits,despite maturing during the most difficult stock market conditions in living memory.
Trying to pick the best with-profits providers in future is an inexact science. An independent financial adviser may take account of life companies' financial strength as measured, among other things, by their free asset ratio or the extent to which assets exceed liabilities. As we saw with Equitable Life, the company offering the highest forecasts and the lowest costs is not necessarily offering the best value. It is also important to understand that with-profits endowments are inflexible contracts where early surrender values for people who do not maintain payments for the fixed investment period may be poor. However for people who are confident they can keep up monthly premiums, with-profits endowments have a long track record of providing above-average tax-free returns with moderate risk and life cover built into the bargain.
Medium term funding
If you have five or more years in which to fund educational costs, a wide variety of tax shelters is available to help you make the most of your money and ease the task ahead. Your options include with-profits bonds; individual savings accounts (Isas) and National Savings & Investments (NSI) certificates. All of these can generate tax-free income or gains, while some are risk-free and others can be used to minimise your exposure to stock market volatility. Bear in mind, though, that the division of this guide into long, medium and short-term funding options is only intended to simplify the investment options available.
In practice, all three time periods will be relevant to most people because funding education is rarely a matter of merely paying this year's fees. Indeed, because costs tend to rise over time - and not just due to inflation, for example, when a child goes from preparatory to senior school there will often be a dramatic increase in the cost of the school fees - it makes sense for your financial planning to stretch many years into the future; even if the first fees must be paid this year.
MEDIUM TERM FUNDING
WITH-PROFITS BONDS
These are the lump sum or single investment equivalent of with-profits endowments, discussed in the previous chapter.The fundamental idea is also the same;to give investors exposure to the long-established tendency for stock market assets to provide higher returns than deposits butwith a structure in place to reduce volatility. As before, retums to bondholders are divided into annual bonuses which, after they have been declared, cannot be taken away - thus providing an'upward only' ratchet effect - and there is the possibility of a terminal bonus, if underlying returns are sufficient, which may be declared when the bond is encashed.
Significant tax advantages of with-profits bonds include the ability to draw up to 5 per cent per annum of the original sum invested in the bond without creating any immediate tax liability - although you may have to pay the difference between basic and upper rates if you are a higher rate taxpayer when the bond is encashed; no further tax liabilities on gains on encashment for basic rate taxpayers; and - an important attraction for older investors - income from these bonds does not diminish entitlement to age allowances. There is no maximum limit on how much can be invested in with-profits bonds.
Unlike endowments, there is no fixed term of investment for with-profits bonds. However, most of the life companies which provide these bonds may impose exit penalties on encashment within five years of investment and, in the current depressed stock market conditions, many impose market value reductions (MVRs).The life companies defend these MVRs as a way of ensuring that people who encash bonds now, when the value of the underlying assets is depressed, do not benefit at the expense of people who continue as bondholders.The fact remains that MVRs can mean the cash-in value of some bonds is a fifth lower than their current value, as shown on statements.
PROOF OF THE PUDDING
So, setting aside the technicalities for a moment, how have these bonds performed? The answer according to an industry-wide survey by Money Management, the magazine for independent financial advisers, is surprisingly well. Over five years, the average with-profits bond turned £10,000 into £12,966 with no further tax liability for basic rate taxpayers. That is equivalent to an annual gross return of 5.3 per cent. By contrast, according to independent statisticians Standard & Poor's, £10,000 invested in the average unit trust tracking the FTSE 100 index over the same five years would have shrunk to £8,086.
MEDIUM TERM FUNDING
Selecting the best with-profits bond provider in future is a complex question, including an assessment of up-to-the-moment financial data, which a professional adviser will be able to help you address.
There is now a more modern version of with-profits, available in part due to one of the many reviews of the Financial Services Industry, where the value of your investment is guaranteed not to fall below 80% of the highest ever value of the fund but where the fund still benefits from stock market based growth, ie it protects the gains made in the good times. This also produces the'ratchet'effect of with-profits making it an ideal vehicle for medium to long term school fees investments. Additionally and very importantly it can be accessed via bonds, Isas arid unit tmsts thus making it potentially tax advantageous to anyone who has not used their various allowances. Again your adviser wil) guide you to its most suitable form.
INDIVIDUAL SAVINGS ACCOUNTS (Isas)
An Isa is a form of'wrapper'which can render a wide variety of investments tax-free, both in terms of income and capital gains, regardless of whether you are a basit rate or higher rate taxpayer.There is no minimum period for which an Isa must be held to be tax-free but the nature of the some of the underlying assets which can be held within the Isa wrapper means it is prudent to regard these as medium to long term investments; that is, for five years or more.The reason is that the price of stock market assets - such as shares or corporate bonds or unit trusts holding these assets - may fluctuate without warning. So, the longer you can afford to remain invested,the less likely you are to be caught out by short term dips in their value; for example, being forced to sell by personal circumstances, such as the need to pay fees now, when prices are temporarily depressed.
Every adult is allowed to invest up to £7,000 in a Maxi Isa or up to three Mini Isas each tax year; It is important to remember that you cannot set up a Maxi Isa and any Mini Isas in the same tax year.5o,for example, if you put as little as £1 in a Mini Isa to be held as a risk-free cash deposit with a bank or building society- the subject of the next chapter-you will have lost the opportunity to invest up to £7,000 in a Maxi Isa during that tax year. However, you could still invest up to £3,000 in the cash Mini Isa; plus up to f3,000 in a stock market Mini Isa and up to £1,000 in an insurance-based Isa, which could hold with-profits savings schemes, similar to the endowments discussed in the previous chapter.
CHOOSING AN ISA
If all that sounds rather complicated, then your independent financial ; adviser will be able to keep you on the right side of the rules. He or she should also help you consider which combination of the underlying assets that can be held in the Isa wrapper is most appropriate for your needs and objectives. For example, while shares have tended to provide the greatest returns over most periods of five years or more, corporate bonds - a form of IOU issued by large companies seeking to raise capital - tend to pay a higher income than shares and have delivered higher total returns over the last five years demonstrating their worth as a'hedge' against share price volatility ie when share prices fall they are more likely to rise although not by as much.
Gilts are bonds issued by the British Government which can also be held tax-free in an Isa and behave in a similar way to corporate bonds.
The relative lack of volatility of these types of investments make them an important consideration when investing for school fees.
MINIMISING RISK
In school fee's planning it is important that the right money is available at the right time. School fees are generally paid over a relatively short period, (although it may not seem like that at the time) when compared with house purchase or pension planning -the other two major financial commitments of a similar magnitude - it is therefore very important to obtain the right balance of risk and reward.One way to diminish your exposure to that risk is diversification; that is, by spreading your money over a number of individual types of investment such as shares and corporate bonds but also including others such as commercial property and foreign equities you can reduce your exposure to setbacks in one particular area.
Unit trusts-and their cousins, investment trusts and open ended investment companies (Oeics) - offer a simple and cost-effective way to achieve risk reduction for investors of all sizes. For example, many unit trusts will accept investments as modest as £1,000 or £100 a month so your adviser could design a specific portfolio for you using individual unit trusts from the various asset classes. Better still, it usually costs no more to hold a unit trust within the tax-efFcient Isa wrapper than it does to hold the same unit trust outside; typical costs are S per cent initial and 1.5 per cent per annum.
TAXATION
The various investment wrappers all provide a slightly different tax advantage. As mentioned earlier bonds can provide income free of basic rate tax and Isas are also tax efficient (hence the restricted amount that can be placed in them). Unit trusts can also offer many people the opportunity to use their, often neglected, capital gains tax allowance. Each person (including children) is allowed to take £7,900 of gain tax free every year. With the correct planning and use of this allowance many people could pay little or no tax on their school fees investment.
NATIONAL SAVINGS & INVESTMENTS
People who require absolute safety and the certainty that they will be able to obtain a fixed sum on a fixed date in the future should consider National Savings & Investments (NSI) as part of their plans. NSI is a department of the British Government which offers a range of risk-free products, similar to those provided by high street banks and building societies, some of which are tax-free.
However, the disadvantage of NSI is that the rates of return tend to be modest. For example, five-year Fixed Rate Savings Certificates currently offer just 2.7 per cent tax-free. It is worth pointing out that, for higher rate taxpayers, this is the equivalent of a gross or pre-tax return of 4.7 per cent. Another consideration is that this rate, paid by the current or 68th Issue of NSI Fixed Rate Savings Certificates, is guaranteed for five years and so cannot be affected by any reduction in base rates during the period. At the same time, there are penalties in the form of loss of interest if these certificates are encashed within their fixed five-year term. Several NSI products can be held for less than five years and, along with deposit-based Mini Isas, are discussed in the next chapter on short term funding.
Funding
Where you need to know with absolute certainty that a fixed sum will be available to pay fees within five years it is prudent to consider risk-free deposits.
Unfortunately, the disadvantage of deposits is that returns tend to be modest - particularly when, as at the time of writing, interest rates are at their lowest levels in half a century. Even so, it can be argued it is not unreasonable that returns should be low when risks are negligible or nonexistent- but only people with very substantial sums of capital are likely to be able to fund school fees entirely on a risk-free, low-return basis.
In practice, deposits with N51 or banks or building societies are likely to provide only one element in a wider portfolio of assets to fund education. As mentioned earlier, most people planning to pay fees must consider commitments stretching over a period of many years and so may benefit from long term, medium term and short term asset allocation strategies simultaneously. The short term element is most likely to be that portion of the fund which cannot be put at any risk and so may ' be held with N51 or in a deposit-based Isa.
SHORT TERM FUNDING
CASH ISAs
Every adult can deposit up to £3,000 each tax year in a cash Isa which is just like a bank or building society account in that your capital is guaranteed but interest is tax-free. Cash Isas can take the form of a Mini Isa or an element within a Maxi Isa, which could also contain up to f3,000 per annum invested in stock market assets and up to £1,000 per annum in insurance funds.There is no minimum period for which cash Isas must be held to be tax-free but some providers may stipulate a fixed term in return, for example, for guaranteeing a fixed rate of interest. Most cash Isas pay variable rates of interest, which may rise or fall depending on money market conditions in the future.
It is important to understand that the annual limits for cash Isas are fixed or once-off limits and not running or rolling limits.ln other words,once you have placed £3,000 in a deposit-based Isa, if you then withdraw any cash from that Isa you are not allowed to subsequently top up that Isa during the same tax year. Another consideration for people with Tax Exempt Special Savings Accounts (Tessas) nearing the end of their fixed five-year term is that they can roll the original capital - but not the accumulated i nterest - over i nto a Tessa-on ly Isa or Toisa, without affecti ng their other Isa allowances.That means up to £9,000 - the maximum capital that could be deposited in a Tessa - can continue to be sheltered tax-free and risk-free in a Tessa-only Isa. But, in another of those odd rules the Inland Revenue insists upon which can trip up the unwary, this opportunity is only available for six months after the Tessa matures.lt is a good idea to consult a your independent financial adviser before your Tessa matures in order to make sure you do not miss this "use it or lose it" opportunity.
BORROWING TO PAY FEES
Finally for people with an immediate need to pay fees for which no other funds are available, it is worth considering credit. Mortgages offer the lowest cost borrowing facility of all - provided you are a homeowner or a buyer with sufficient 'equity' in the property. This is defined as the difference between its current market value and the debts attached to it. After years of rising house prices, many homebuyers enjoy substantial equity in their property and most lenders are flexible about extending either the sum advanced or the repayment period - possibly both - subject j to status or the specifics of each individual case.
For example, Halifax, the biggest mortgage lender, currently charges a standard variable rate of 5.65 per cent. That is less than half the interest rates charged by Barclaycard, the biggest credit card, which currently vary between 11.9 per cent and 24.9 per cent on purchases of goods or services.The higher rate is applied to people with poor credit ratings. It is also worth pointing out that, where a cash advance is drawn from a credit card, even higher rates may be charged. For exampl~,p in the case of Barclaycard, cash advances attract interest at between ~~:3 per cent and an eye-watering 24.9 per cent.
However, it is important to understand the difference between secured and unsecured loans. One reason that mortgage rates are lower than credit card or personal loan rates is that, unlike those last two forms of credit, mortgage advances are secured against your home.That means you may lose your home if you do not keep up repayments.On a brighter note, competition between lenders is fierce, creating opportunities for customers who are willing to shop around to cut costs substantially. In particular, remortgaging - that is, arranging a new homeloan without moving house - could free up substantial sums by reducing interest costs and monthly bills in future.This may well be one of the options considered when conducting financial planning to take account of all your family circumstances, or both sides of the household balance sheet, which is the subject of the final chapter.
Conclusion
Planning to fund education can be a catalyst or trigger for sorting out family asset allocation to make the most of your money while keeping tax bills to a minimum.
In addition to selecting savings and investments for the short, medium and long term strategies discussed in chapters 2,3 and 4 there are issues as diverse as inheritance tax and mortgage costs to consider. Given the complexity of many of these issues - and the sums of money involved many people may benefit from independent financial advice, however "School Fees Planning" is a specialist area of financial planning and as such there may be many advisers who will not be able to, or want to provide this category of advice.
For example, many grandparents are keen to help meet the cost of funding education.This opens up the possibility of 'killing two birds with one stone' by structuring the grandparents' contribution towards educational costs in such a way to minimise the family's liability to inheritance tax. Remember that this tax is imposed at a fixed rate of 40 per cent on estates -that is, all assets minus liabilities at the time of death - in excess of £255,000. Many family homes alone exceed that threshold and, contrary to what many people imagine, assets held in Isas or their forerunners Personal Equity Plans (Peps) are not exempt from inheritance tax. As a result, many owners of by no means palatial homes might accumulate, after a lifetime's work and saving, an estate of f500,000 which, if no avoidance action is taken, could generate an inheritance tax bill of nearly £100,000.
Setting aside a couple of hours for financial planning could prove the best investment you make this year. As we have seen, the 'do nothing' option could prove very expensive. But the tax rules are now so complex that many families pay more tax than they need to on their income and also on their gains from investments. For example, few husbands and wives reallocate assets - such as bank deposits, shares and unit trust holdings - to benefit from a non-earning spouse's personal allowances to receive up to £4,615 of tax-free income and up to f7,900 of tax-free capital gains. Even fewer make use of their children's entitlement to the same allowances.
The good news is that effective financial planning can utilise the full range of exemptions and allowances to place more of your family funds beyond the grasp of the taxman.Care does need to be taken,though,to stay on the right side of the rules and avoid various pitfalls. For example, income generating assets given to children by parents will be taxed as if it is still the parents' if total annual income exceeds £100. No such clawback rule applies to gifts from grandparents. Once again, an independent financial adviser will be able to help you through the fiscal maze.
As mentioned in the introduction, investors are right to be sceptical about salesmen who merely wish to sell them investment products. By contrast, an independent financial adviser should take care to conduct a thorough fact finding examination of all your relevant details, including assets, debts, and attitudes toward investment risks and rewards.Only then should he or she make recommendations and that should not be the end of the relationship but the beginning in which the adviser continues to monitor the progress of the plan agreed.
However, unlike most forms of financial planning, there is an additional pressure on people preparing to fund education. After all, if a mortgage repayment plan - such as an endowment - should disappoint, you can always extend the repayment period by a few years.There is less flexibility about funding education because the timing of when costs arise is dictated by when your child or children reach the various stages in their school and university careers. People who find themselves short of funds when their child gains a place at their chosen university can hardly delay acceptance of the undergraduate's place until cash comes to hand. So it is vital to get this form of financial planning right first time.
