By Louise Misiewicz
Are you planning on sending your child to a private school?
Worried how much it will cost, or extra tax you might pay?
A lot of people, including myself, are thinking about sending our children to private schooling.
The cost can range significantly per term across the UK but let’s assume that the level of fees is circa £12,000 for one year. If you are a high rate tax payer, you would need to earn £20,000 when you consider than you are paying 40% income tax of £8,000. This is a significant chunk of money.
If you are a high rate tax paying business owner and wish to take the £12,000 school fees as the dividends total dividends to be paid would be £17,788, due to the income tax rate of 32.5% being £5,778. Let’s not forget that the company would have also paid 20% tax on its profits, so the story is much worse.
Some parents may buy income-generating assets for their children, but the issue with this approach is that income generated from assets being passed from parent to child is taxed as though the income was generated by the parent. Again, this can be a costly mistake from a tax perspective.
As you can see from the above example, it’s a very expensive way of paying private school fees.
Instead of taking this approach, why not use a family Trust so that it may pay for school fees instead?
It’s much better for grandparents to gift assets into Trust, as the income generated by the assets may be passed onto the children without it affecting the parents’ tax position.
The above scenario works perfectly for family businesses, where the shares of a grandparent are passed into Trust and the beneficiaries being their grandchildren – in particular, to pay for private school fees.
What is a Trust?
A Trust is a way of passing the benefit of assets to other people without them taking possession of the funds outright. You can retain control of the capital, continuing to manage the investments as you wish, while ensuring it is used to benefit future generations.
This is much better than paying your young child money for them to buy lots of lollipops.
In addition to the tax benefits, a Trust can help protect the assets that form the trust fund against difficult situations in the future, such as the divorce or bankruptcy of one of the beneficiaries.
The example here is when your child marries after receiving your gifted assets but subsequently gets a divorce the assets you originally passed onto them is shared. Therefore the £50,000 (say) gift of assets is valued £25,000, within the family tree, after the divorce. I am assuming that you wouldn’t buy anything if you thought it would only be worth 50%.
One key benefit is its flexibility.
It can be as constrained or as wide-reaching as you like in regard to capital and income distribution.
For example, you could instruct that income has to be split between children equally, regardless of their circumstances, or you could leave it to the Trustees to decide annually who should receive what monies.
Trusts should always be drafted by a professional to avoid legal pitfalls.
There are two types of Trust that can be used for the payment of school fees:
- Bare Trust
- Discretionary Trust
I wrote about these in another article so will not go into too much detail here.
Bare Trust & Discretionary Trust
A Bare Trust is one where the beneficiary has an immediate and absolute right to both the capital and income held in the Trust. Bare Trusts are sometimes known as ‘simple Trusts’.
In a Discretionary Trust, the trustees are the legal owners of any assets – such as money, land or buildings – held in the Trust. These assets are known as ‘Trust property’.
The Trustees are responsible for running the Trust for the benefit of the beneficiaries. The Trustees have ‘discretion’ about how to use the Trust’s income.
They may also have discretion about how to distribute the Trust’s capital. The Trustees may also be able to ‘accumulate’ income – add it to capital.
I would say that a Discretionary Trust provides greater asset protection and flexibility.
The difference between them is that the Discretionary Trust is taxed as though it was an individual at the highest tax rate, but can be claimed back by the beneficiaries on their self-assessment.
Don’t forget that after 6th April 2016, anyone can now receive £5,000 dividends per year tax free. As minors, I would be surprised if they were anything other than basic rate tax payers. If school fees were circa £12,000 then the first £5,000 would be tax-free, leaving remaining money to be taxed at just 7.5%. This is much better than parents/grandparents being taxed at 32.5%/40%/45%.
This is much better than parents or grandparents being taxed at 32.5%/40%/45%.
HMRC reporting requirements for a Discretionary Trust can be an administrative pain. The Trustees have to meet regularly to discuss investing the funds and using the capital and income effectively for the beneficiaries’ benefit; they also have to produce annual accounts.
HMRC reporting for Bare Trusts are simpler. While there is still a need to produce annual accounts, if the income is mandated to the beneficiaries the accounts are relatively simple to prepare.
While there is still a need to produce annual accounts, if the income is mandated to the beneficiaries the accounts are relatively simple to prepare.
The Trustees have to meet regularly to discuss the investment of the funds but, as they have no discretion as to their distribution, the overall administration of the Trust is simpler.
Inheritance (IHT) tax planning points
The transfer of assets in a lifetime is potentially taxable for inheritance tax purposes. If you transfer £400,000 of assets in a lifetime and you pass away within one year then the gift of £75,000, over and above the IHT limit of £325,000 is chargeable to tax.
By transferring assets from your grandparents estate into a Trust during their lifetime also reduces the IHT liability upon death.
I have written more about IHT on this article.
Step-by-step guide to implement this strategy
It is one thing to understand the theory but it is another to implement the above successfully. That is why we have created a step-by-step guide:
- Ensure that the company structure is set up to include grandparents with the correct types of shares
- Set up the Trust and move the beneficiary element of the shares into it
- Payment of dividends to the Trust
- Pay out school fees
- Prepare and submit tax returns for both the Trust and child(ren)
How to engage with us
If you want to understand how to implement this strategy or to discuss other finance/tax questions then please book some time with us using the below calendar.
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