Overview

If you are contemplating paying for private education for your children, these trusts can be quite useful for IHT planning; quite simply, you place a sum of money intended to fund your children's education up until the end of university into trust now rather than paying on an ongoing basis.

Normally, any payments you make towards your children's education are not considered gifts; they are payments on behalf of a financial dependant and as such they are exempt from IHT.

This rule still applies, whether you pay school or university fees as they arise or, instead, place a lump sum calculated to pay for your children's entire education into a trust in one go. As the payment is not considered a gift for IHT purposes, there will be an immediate reduction in your estate for inheritance tax purposes and you don’t need to worry about waiting 7 years before such a gift is outside of your estate.

The limit on the amount that can be given is what is reasonable for your children's education. For example, if you calculate that you would need £200,000 to complete your children's school and university education and then put that into an education trust, there will be an immediate reduction in your IHT liability of £80,000. To the extent that the funds are not used, they revert back to you or to your estate after a set period of time (usually at the end of your children's education).

The difference between setting up the trusts during your lifetime and setting them up in your will is that your estates will suffer tax at up to 40% before the school or university fees are paid.

There are some disadvantages to education trusts:

You need to have the funds to be able to constitute the trust in the first place.

The trusts must be properly set up and managed; if done professionally this will mean fees which would not be incurred if you simply continue paying for your children’s education from your own funds. However, with the exception of set up costs these should be relatively minimal each year especially in comparison to the tax saving made.
Once the money has entered the trust you will have no further access to it, unless one or more of your children do not complete their education and there are funds leftover. This can likewise be advantageous, if you are concerned about your future risk factors, such as bankruptcy if you run your own business.
The tax benefit only applies until the age of 18 or the end of tertiary education if there are no breaks; so this means no gap year trips at 18.

Considerations

A cost-benefit analysis may assist in deciding whether to set up trusts of this nature. I would estimate set up fees of £1,800 including VAT and, if the trust is managed professionally (which is not essential), perhaps £1,500 to £2,000 per year in management fees (to prepare tax returns and accounts, for example). If the trust fund is invested through an investment manager there may be fees payable in that respect.

Often these types of trust are used in "death-bed" planning scenarios for parents of young children. They can, however, also been seen as a form of insurance policy, so if you were to both die before the children complete their education, your children would be better off.

Looking for other solutions?

If using education trusts doesn’t appeal to you then there may be other ways of funding your children’s education in a tax-efficient way; for example, many schools offer a discount if you pay fees for several years in advance; the discount reflects the fact that the school (if it has charitable status) can invest the money and doesn’t pay income tax or capital gains tax, whereas you would suffer income tax at 40-45% and CGT at 28%.

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