How paying school fees can ease grandparents’ inheritance tax woes

The decision to send children to private school is not one to take lightly; according to numbers from the Independent Schools Council, the average cost for a place at a private day school is now £16,656 a year per child.

That works out at a total of £116,592 a child for parents who send their children to a private secondary school until the end of sixth form – and that’s without factoring in any increases to fees over the years. This year, fees were up 5.6% - the biggest hike since 2009.

£50,000 a year bills

For children attending the most prestigious establishments, the costs can be even more staggering, with Eton College, Harrow School and Cheltenham Ladies College all charging in the region of £50,000 a year.

And costs will of course be even greater if the plan is to send children to a private primary or prep school first.

Even working on the cost of the average private day school, a higher-rate taxpayer with two children would need pre-tax earnings in the region of £55,000 a year just to cover their school fees.

However, wealthy grandparents can potentially ease the pressure on their adult children and, at the same time start to mitigate a brewing inheritance tax (IHT) liability, by helping with the cost.

The growing spectre of IHT

UK families are paying more IHT than ever before when their loved ones die. In 2022/23, IHT receipts reached £7.1 billion, according to figures from HMRC, an increase of more than 108% over the past decade.

And the trend has continued into this tax year. The latest figures show that IHT receipts hit £3.2 billion in the five months from April to August 2023, up £300 million on the same period a year earlier.

Currently IHT is charged at a rate of 40% on estates worth more than the nil rate band, which is £325,000, or £500,000 if you are leaving a family home to your children or grandchildren (the residential nil rate band). As transfers between spouses are tax-free, this means a married couple with a house can effectively leave £1 million to their children before they need to worry about IHT.

However, while the introduction of the residential nil rate band in 2017 has made it easier to pass property wealth onto younger generations, rising house prices in combination with a nil rate band that has been frozen until 2028, means the number of families affected by IHT will only continue to grow.

Why it pays to be generous

The most straightforward way to reduce the amount of IHT your loved ones pay is to start giving away money you won’t need. The less money you have over the nil rate band, the lower the tax bill will be.

So, if you have grandchildren, helping with school fees can kill two birds with one stone: you reduce your IHT bill and get to enjoy seeing your grandchildren benefit from your wealth. Your children will hopefully value your generosity and worry less about their own finances too.

IHT gifting rules

IHT gifting rules mean you can’t necessarily give away as much money as you would like. However, there are a number of allowances you can take advantage of.

These can help whether you are paying all the school fees or making a contribution.

Gifts from surplus income: This is a really helpful allowance for wealthy grandparents who are regularly helping with school fees. You can give away as much of your income as you would like, the only restriction is that you must be able to demonstrate that the money is surplus to your requirements and that you are not harming your standard of living by making the gifts.
Annual exemption: Each year you can also give away £3,000 to whoever you like tax free. Couples can join forces to gift £6,000 tax free between them. You can also carry forward last year’s allowance if unused – although you can only do this once. The annual exemption can also be combined with a gift from surplus income and paid to the same person.

However, even if these allowances aren’t enough to cover the scope of your gifting, there may still be no IHT to pay.

That’s because any gifts you make in excess of the permitted allowances are considered to be ‘potentially exempt transfers’ and subject to the seven-year rule.

This means that if you live for at least seven years after making the gift, it will be considered as wholly out of your estate and won’t be subject to any IHT.

If you die before seven years have passed, taper relief may apply to any gifts that exceed the £325,000 threshold:

Years between gift and death	Rate of tax on the gift
3 - 4 years	32%
4 - 5 years	24%
5 - 6 years	16%
6 - 7 years	8%
7 or more	0%

Using trust funds

Rather than making payments direct to the school or your children, there may be tax advantages to using a trust to fund your gifts.

By gifting money into a discretionary trust, the trustees (the grandparents and/or the parents) would have control over how the underlying capital is managed, but the income generated could be used to pay for school fees.

This can be helpful from an IHT planning point of view. Grandparents can place assets into trust worth up to £325,000, and they will be free of IHT so long as they survive seven years after the gift was made. However, the added benefit of funding school fees in this way is that the income generated by the trust will be taxed at the beneficiary’s rate of tax – that is the child’s. As the child is likely to pay a lower rate of tax than other members of the family this can provide quite a substantial saving.

It's also possible for the trust to carry on running once the child has left school and be used to help fund life at university.

Trusts, however, are complex and grandparents won’t be able to take any benefits from the trust once it has been set up, so it’s important to seek professional advice.

A family affair

If you have a looming IHT liability and would like to help fund private education for your grandchildren – or want to help with university expenses when they are older – it’s a good idea to start discussing it with your children and making plans sooner rather than later.

Unless you are going to be footing the whole bill, your children will need to work out how they will find the money, and it helps to set up a savings or investment plan as soon as is feasible. This could be as soon as the children are born, potentially even as soon as they get married or start planning their futures together.

By saving for big expenses over a longer period of time, you’ll be able to make the most of compounded returns and will need to save less overall than you would if you had less time on your hands.