The cost of funding children through private school or university is becoming ever more daunting. However, there a few tax efficient options available to parents and grandparents to help alleviate the costs.
Paying tuition fees, accommodation and living expenses out of income that has suffered tax and national insurance at rates of up to 62% requires a huge amount of gross income. There are, however, a number of ways in which the overall cost burden can be reduced.
Opportunities for children over 18
For adult children, the most efficient ways of funding university fees are those which enable income to be taxed on the child rather than the highly taxed parent or grandparent, thus making use of their personal allowance and basic rate tax bands. This option is not available to parents of minor children as any income in excess of £100 which originates from a parental gift is taxed on the parent who gave the gift and not the child. This rule does not apply to gifts to minor children from other family members so can be effective in circumstances where grandparents make gifts to minor children. Below we explain some of the opportunities that can be used to facilitate this.
Trust planning for investment assets
Tax savings can be made by parents transferring investment assets into trust for the benefit of their adult children but they do need to be aware of the above rules and, therefore, grandparents have far more scope and can create trusts for the benefit of grandchildren of any age. Where the funds are being used to pay school fees, care should be taken to ensure that the Trust/Trustees contract with the school to pay the fees, rather than reimbursing the parents otherwise the payments could be considered distributions to the parents rather than the child.
The benefits of trusts are multiple: income generated in the trust can be paid to the beneficiaries whilst reducing the donor’s estate for IHT purposes, but at the same time enabling the donor to retain a certain amount of control over the investments by being a trustee of the trust. It can also protect the family’s assets from the beneficiaries suffering a divorce or bankruptcy.
Another benefit of using a trust for transfer of investment assets is that it is possible to hold over any capital gain arising on the transfer into trust meaning that there does not need to be a capital gains tax (CGT) cost in setting up the trust. However, consideration does need to be given to IHT, as transfers of value in excess of the donor’s IHT nil rate band could lead to a lifetime IHT charge.
Shareholders in family companies
Grandparents who are shareholders in a family company can transfer shares, either directly or via a trust, to their grandchildren. This could allow each grandchild to receive annual dividends of up to £14,570 a year tax free and at a rate of just 8.75% on the next £35,700 of dividend per child per annum. A dividend of £14,570 paid to a child with little or no other income could save the family tax of over £5,700 a year. The rules for parental gifts mentioned earlier restrict the tax efficiency of this planning for parents of minor children but could be used once children reach the age of 18.
If the family company is a trading company, this planning can often be undertaken without any tax liabilities arising on the transfers. Planning is more difficult with investment businesses as there are likely to be inheritance tax and capital gains tax charges to consider, although the use of trusts can alleviate the latter.
Family investment companies
Family investment companies (FICs), sometimes referred to as personal investment companies, are an alternative to personal or trust ownership of investments and offer a number of advantages when it comes to retaining and growing family wealth.
Adult children could be shareholders in the FIC and receive dividends from the company so that they benefit from the lower rates of tax highlighted above.
FICs offer further planning opportunities from remuneration and pension planning to capital preservation and we would be happy to discuss their potential use further.
Parents and grandparents are sometimes looking at the possibility of buying property for their children to live in while at university, both as a means of saving on rental costs but also as a longer term investment opportunity. However, it is important to consider all the ownership options available before committing to a purchase to ensure maximum post tax efficiency is made from any investment return and future sale proceeds.
If rental income will be received from other students, care needs to be taken to ensure that it is not taxed on the parents, and also ensuring that important CGT exemptions like main residence relief and letting relief are maximised on a future sale.
Other planning options
There are a number of tax-incentivised savings options available to help build up funds for children that should not be overlooked and can be used in unison with the above. These include junior ISAs and Premium Bonds. Your financial adviser will be able to advise further on these, and if you do not have one, we would be happy to refer you to our very own Rickard Luckin Financial Services team.
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