Private education costs in the UK are continuing to skyrocket, with fees rising by almost 6% annually. Families can now expect to pay over £5,000 per term for a day school or £13,000 for boarding, with some schools charging more than £50,000 a year.
In the past, the supply of education was typically VAT exempt, which meant private schools did not charge VAT on their fees. However, following through on its general election manifesto pledge, the Labour Government announced that from 1 January 2025, the VAT exemption on fees would be removed, further adding a significant increase in cost to the public.
This has meant in the short term that more parents are relying on financial support from grandparents to help meet the rising cost of school fees. However, it’s important to consider the consequences before accepting this assistance.
Depending on who makes the transfer and when it is made, paying school fees could trigger unexpected inheritance tax liabilities. Before tapping into the bank of grandma and granddad, it’s crucial to understand the potential implications.
Inheritance Tax
Inheritance tax does not apply to transfers made for the education of children under 18 or in full-time education. However, there are important details to consider. These transfers are only exempt from inheritance tax if they were made by the parent, unless the child is not in the parent’s care. This means that grandparents and other relatives will generally not benefit from the exemption, even if the transfer is made directly to the school. This may seem like a limitation, but there are ways to work around it.
Everybody has a £3,000 annual gifting limit without having to pay inheritance tax. And, if you have never used this allowance before, you can carry that £3,000 over in the first year and actually donate upto £6,000 per person. This could enable grandparents to each donate up to £12,000 in the first year, followed by £6,000 in each succeeding year.
While this would reduce the costs of private education, however, it will not fully offset the annual expense. But there are other possibilities for individuals who are able to and want to contribute more.
Contributions
If you survive for at least seven years following the gift, you can give away a lot of money without having to pay inheritance tax. This suggests that paying for higher education more upfront rather than in yearly instalments may be advantageous.
However, the amount of money you have within the £325,000 tax-free exemption at the time of your passing, as well as the value of your entire estate, will determine whether or not any transfers are liable to inheritance tax.
If you imagine a set of grandparents that have enough money saved to cover the school fees for their two grandchildren, adding up to £222,000 over the course of their education.
If their estate is worth £600,000 and includes a property that they plan to leave to their direct descendants, and they have not made any other gifts during this time, then they would not owe any inheritance tax even if they passed away within seven years. This is because their assets and gifts would be covered by their combined allowance of £1m.
However, if the grandparents’ estate is worth £1m, then the £222,000 would exceed their allowances, and they would owe inheritance tax on the gift if they were to pass away within seven years.
When grandparents generously contribute to school fees, they often create a trust for the child. This is a wise move due to the tax benefits it offers. By establishing a trust, the trustees maintain complete control over how and when the assets are used. However, since the child is the ultimate owner of these assets, they will be taxed based on their own income and capital gains tax allowances/exemptions.
There is another alternative solution for distributing unlimited funds without being bound by the seven-year limitation.
Paying for tuition on a monthly basis can help grandparents avoid inheritance tax on transfers, so long as they have enough disposable income. However, certain requirements must be met in order for these contributions to be excluded. By satisfying Section 21 criteria, these payments can be classified as typical expenditure out of income, ensuring the preservation of your loved ones’ quality of life.
If you choose to employ this strategy, it is of utmost importance to maintain thorough records of your annual income and expenses. The HM Revenue and Customs will request this information from your executor after your passing.
We would always advise seeking the assistance of an experienced wealth manager before deciding upon the most tax-efficient way to support your family in the future, as the pitfalls can be substantial if mistakes are made. Our dedicated private wealth team would welcome the opportunity to discuss the possible options with you.
*This blog has been updated to reflect the legislation as it applies in 2025
