Wealth Questions - How to save for son’s school fees

My husband and I are higher-rate tax payers who make full use of our individual savings account (Isa) and capital gains tax (CGT) allowances. We want to save for the future school fees of our son, who is currently six months old. We looked at investing in shares via a “bare trust” in order to make use of his personal tax allowances, but were told that this structure would not allow us as trustees to withdraw the funds to pay his school fees, as only he could withdraw the funds himself at age 18. Are there any other ways that would allow us to save and invest tax-efficiently towards his school fees?

Matthew Woods, partner at solicitors Withers, says that the position may be improved by using a bare trust that includes specific powers of distribution.

The concern with a simple bare trust is that, at age 18, your son could complain that the funding of his school fees was not for his benefit. While this would be a difficult argument to sustain where you had provided the funds, if a bare trust includes specific powers to use the funds for your son’s expenses, any risks should be reduced.

A significant advantage of a bare trust is that your son’s annual capital gains tax (CGT) exemption, currently £10,100, is available. If there are gains above his annual exemption, they will be taxed at the lower rate of 18 per cent. However, any investment income will continue to be taxed as yours while your son is under 18 and so the objective should be to invest for capital growth to minimise tax.

The income tax position would be different if someone else, such as a grandparent, were to provide the funds. In that case, your son’s personal allowance and lower-rate tax bands would be available and so the investment policy could be more flexible.

If you are still concerned about using a bare trust, you could invest through a more complex structure, such as a discretionary trust. Your son would have no entitlement to the assets at 18 and the trustees could use them to fund school fees in the meantime.

You would, however, lose some of the tax benefits of a bare trust as gains would be taxed at the standard trust rate of 28 per cent and the trustees would have only one half of your son’s CGT annual exemption – £5,100.

In addition, the trust would be potentially subject to inheritance tax (IHT) charges every 10 years. In practice, there would be no IHT to pay unless the funds exceeded your nil-rate bands of £325,000 each, but a tax return would need to be filed every 10 years.

It is also worth considering whether school fees can be paid upfront, since many schools offer attractive discounts.