Parents will be painfully aware of the ever-increasing costs of a university education for their children, especially in England. Throw in the additional cost of accommodation and living expenses and the privilege of a further education is set to come at a high price for many.
Crunching the numbers shows that students starting a three-year course from 2012 could need around £14,500 per annum to cover fees and living expenses. Assuming only modest inflation at 2.5 per cent, the same student starting university in 2020 could need £54,500 to fund a three-year course.
Even before the latest hikes in fees, research shows that many parents underestimate the costs involved and end up struggling to cope. And while research shows that those obtaining a degree have a higher earning capacity throughout their working lives, students are increasingly finding that full-time employment is taking longer to secure.
The knock on effect is that they are left – or more likely their parents – saddled with a large debt, unable to save for that important first property purchase and still living at home well into their thirties.
To avoid this, early planning is required by parents and grandparents to mitigate the costs involved. Collective savings vehicles such as funds and cash deposits can be used to underpin your investment strategy, but tax efficiency is an important consideration in order to maximise gains. One particularly flexible and tax efficient vehicle to help parents and grandparents with the spiralling costs of providing a further education is the use of offshore bonds.
An offshore bond is simply an insurance ‘tax wrapper’ placed around your investments. Most major insurance companies offer these wrappers. Based offshore, investments within the wrapper grow tax free, other than any non-recoverable withholding taxes. So if an offshore bond is set up when children or grandchildren are young, this will give it plenty of time to grow in a tax efficient environment.
Once the bond is established, you can manage your investments to suit your risk profile and financial goals without triggering a tax charge. Plus, you still have access to the capital should you require it. Withdrawals from the bond are subject to income tax, although you are able to take five per cent per annum of the original investment with no immediate tax liability. In addition, this allowance is cumulative – which means in years the allowance is not used, you can carry it forward to other years.
This may be a useful way of drawing money to pay for the private education of children prior to university, while they are still minors. Later on the bond can be used to meet further education fees in a way that is likely to be advantageous for both income tax and inheritance tax (IHT). This can all be achieved without the need for a trust.
If either or both parents are higher rate taxpayers, then an offshore bond can become an even more efficient way of funding education fees. This is because the bond can be structured as lots of different ‘segments’. Once the children reach the age of 18, bond segments can be assigned to them. The assignment will not be a chargeable event — that is it won’t create a tax charge, and any subsequent chargeable event will be assessed on the assignee who, as a student, may well be a non-taxpayer. Any unused personal allowance can be set against the offshore bond gain, so significantly reducing any tax bill.
There is also an inheritance tax advantage to this strategy. You might think that the assignment of bond segments from the parents to their adult children will not become exempt for IHT purposes for seven years. In fact, it is likely to be immediately outside the parents’ estates as the transfer is for the education and maintenance of their own children while in full-time education.
Mark Brownridge is a Research and Development Analyst, Mazars Financial Planning
If you would like to ask the author a question on this or a related topic email: carpediem@mazars.co.uk
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So how does it work in practice?
Chris is 52 and owns his own logistics company. His current earnings are £120,000 a year. His wife, Amanda, is aged 49. She works in the pharmaceutical industry and is a higher rate taxpayer. They have two children Jamie, aged 10 and Karen aged eight.
Both Jamie and Karen are already showing signs of wanting to follow in their mother’s footsteps. Chris and Amanda are aware of how expensive a university education has become, especially for longer courses like medicine.
Chris and Amanda both wish to retire by age 60 and enjoy a comfortable retirement, taking plenty of holidays – without the kids! They both make significant contributions to pension plans and while their pension income is likely to be very generous by most people’s standards, they are concerned that it will not be able to support two long university courses and their retirement plans.
Follow our three-step plan to a potential solution and how it can work in action.
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1. Solution
Together, they have already accumulated £120,000 of savings for the children’s education fees, which is currently held on deposit. They are prepared to take a little more risk with this money and would like to ensure it is tax efficient.
Solution – they invest £120,000 into an offshore investment bond made up of 10 segments of £12,000 each.
Chris and Amanda plan to assign one segment a year to each of their children for the five years of their study. The assignments will not be chargeable events and Jamie and Karen will be able to encash the investment bond segments at their own tax rates, rather than the higher rate of their parents.
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2. Jamie’s first year
Jamie is now 18 and in his first year of university. Assuming a six per cent a year increase in value after charges, the segment has grown in value to £19,126 and the gain on the segment is £7,126. The basic personal allowance has increased to £9,108 – assuming 2.5 per cent a year increase – Jamie has no income in that year.
If Jamie cashes in the segment there will be no tax payable, as the entire gain will fall within his personal allowance. This compares with 50 per cent that would be payable if Jamie’s father, Chris, had cashed in the segment himself and given the cash to Jamie.
This can be repeated for each year of the children’s studies and significant tax savings can be made each time.
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3. Karen’s final year
The final segment has grown to £27,130 and the gain on this final segment is £15,130. The personal allowance has grown to £10,562. Karen has no other income in the year, so she can soak up the gain as follows. Using her personal allowance of £10,562 leaves a taxable gain of £4,568. Karen will pay the starting tax rate of 10 per cent on £3,617 of this and then the basic 20 per cent tax rate on the remainder as follows:
* Personal allowance £10,562 at 0 per cent = NIL
* Starting rate £3,617 at 10 per cent = £362
* Basic rate £951 at 20 per cent = £190
* Total £15,130 = Total tax payable of £552. This is an effective tax rate of just 3.6 per cent
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