Smart ways to beat Labour's private school fees tax

Private school fees are set for a hike. The government is going ahead with its plan to end the VAT exemption for such schools from 1 January next year, and some of the costs are going to be passed on to parents.

If you are hoping to send your children to private school, or if you would like to help pay for your grandchildren’s fees, planning ahead and investing as early as possible can make all the difference. You have a few tax-efficient options to consider.

How much will fees increase?

VAT is levied at 20 per cent and will apply to both education and boarding fees. But just like other businesses, private schools will be able to reclaim the VAT they pay on goods and services, meaning the government estimates that their VAT bill will actually amount to about 15 per cent of the fee income they earn. It will be up to individual schools to decide how much of this will be recovered via fee increases, with the government saying that it expects schools to take steps to minimise these rises.

Gabby Donald, partner at Blick Rothenberg, notes that the 1 January implementation date is tighter than many had expected. “Schools will now be in a race against time to work out the amount of VAT they can deduct on their own costs due to this policy change – this will be an important step in working out how much cost will need to be passed on to parents,” she explains.

Laura Suter, director of personal finance at AJ Bell, says that even a 10 per cent increase would be significant given fees' existing levels – it would mean average day fees going from £18,064 to £19,870 a year, and average boarding fees rising from £42,459 to £46,705. She estimates that for a child starting school in autumn 2025, this rise would bring the average total cost of day private education from reception to year 13 to £408,902 (assuming annual fee increases of 5 per cent – over the past two decades, private school fee increases have tended to be in excess of inflation).

The changes announced by the government came with anti-forestalling measures: from 29 July, VAT will apply even if you pay school fees in advance, for school terms starting on or after 1 January 2025.

Investing for school fees

If you are aiming to send your children to a fee-paying school, investing regularly and starting to do so as early as possible are your best bets in order to be able to cover costs. There are some similarities with investing for a pension: you can take a more aggressive, equity-focused approach at the start, and then gradually move a portion of the portfolio towards safer, income-generating assets as the time to draw from the investments approaches. Once your children start school, you can have two or three years’ worth of fees in cash and other low-risk assets, while the rest of the portfolio can stay invested and keep growing to fund later school years. 

Alice Haine, personal finance analyst at Bestinvest, notes that parents investing when a child is a baby or toddler typically have a healthy investment time horizon, with “enough time for a long-term, diversified investment strategy to potentially deliver the returns they need”. But this depends on when you would like your children to start private school – it could be at the age of five for primary education, or 11 or 13 if you opt for secondary education only. If you only have a few years between your child’s birth and the time when they start school, you will have to think carefully about how much risk you can afford to take with the money. 

The best account for parents to invest for school fees is typically their own stocks and shares individual savings account (Isa), which ensures that all the income and gains generated by the portfolio are tax-free. Junior Isas are a great option to generally invest for your children’s financial future, but they are not suitable for school fees because the money cannot be accessed until the child turns 18.  

Grandparents

Grandparents can help pay school fees while obtaining tax advantages in the process. If you think you may have an inheritance tax (IHT) liability in the future and are already considering giving away some money to your family, it may be rewarding to use it to fund your grandkids’ education.

One simple option is to transfer the money to your children and ask them to use it for this purpose. Gifting rules will apply, so the gift will become free of IHT as long as you live for seven years after making it. You can also give away £3,000 a year without it being added to the value of your estate, or give as much as you like as long as it meets the conditions for the 'gifts from surplus income' rule. In order to qualify, the gifts need to be from your income and not from capital, they need to be regular, and you have to be able to make them while maintaining your standard of living – all conditions that paying for school fees can potentially meet.

Alexandra Loydon, private client director at St James's Place, says that for grandparents it can also make sense to pay into a savings account or an investment account held in the child’s name, in order to make the most of the child’s tax allowances.

When a parent puts money into their child’s savings account, any interest it earns above £100 is taxed as if it were the parent’s money. But this does not apply to grandparents. Children can typically receive up to £18,570 in income or interest per year without incurring tax; this is made up of the personal allowance of £12,570, the starting rate for savings of up to £5,000 and the personal savings allowance of £1,000.

Investing the money via a dealing account is also an option. This is normally set up as a bare trust, with the parent or grandparent acting as a trustee. If the grandparents (rather than the parents) are putting money in the trust, both income and gains generated are taxed according to the child’s circumstances. Just like adults, children have a capital gains tax (CGT) allowance, set at £3,000 for the current tax year. The money in the trust can be accessed at any time as long as it is used for the child’s benefit, and the child gains control of it when they turn 18.