According to the Independent Schools Council census, in 2023, the average cost of private school fees is £16,656 a year for day schools, with the typical fee level 5.8% higher than in 2022.
With children now back at school (unless they are closed because of RAAC!), Myerson's Wills, Trusts and Probate team take a look at Educator Trusts.
What is an Educator Trust (ET)?
ETs can go by many different names, but they are typically a trust whereby a grandparent puts some of their assets into trust to reduce the Inheritance Tax (IHT) their estate will pay while making provision for their grandchildren's school fees.
The Trustees will invest the assets to generate an income which will pay the grandchild's school fees (with the underlying capital available to be used if necessary).
The main types of ET used are a Discretionary ET and a Bare ET.
What are the benefits of a Discretionary ET over just paying my grandchildren's school fees?
Each grandparent can put up to £325,000 (depending on the gifts made in the previous seven years) into a Discretionary ET, with no initial IHT charges.
While the gift will be treated as part of their estate for seven years, if they survive seven years, their tax-free allowance resets and the gift will no longer be part of their estate for IHT.
Making a payment into a Discretionary ET early on, rather than making payments towards school fees each term/year, increases the likelihood that the gift will not be taxable to IHT.
IHT is typically charged at 40%, so a gift of £325,000 can result in an IHT saving of £130,000.
While the trust will initially pay income tax at 39.75% (on dividends) or 45% (on all other income), payment of a grandchild's school fees will be for the benefit of that grandchild, which means the income will be taxed at the child's tax rate, and any overpaid tax can be reclaimed.
If the grandchild has no income of their own, the first £12,570 will be tax-free, with the next £37,770 taxed at 20%.
If a grandparent pays school fees directly and pays tax on their income, they will need a larger income to pay the same amount of school fees.
How about a Bare ET?
There is no limit on the amount you can put in a Bare ET. As long as you survive for seven years, there will be no IHT consequences.
The income will be taxed directly on the grandchild, meaning there is no need for any tax reclaims.
I am a parent; why can I not use an ET?
If your children are over the age of 18, you can use a Discretionary ET!
This could be used to pay for university fees.
If your children are under 18, tax rules mean that any income your child receives will be taxed as if it were your income, so there is no income tax advantage.
It is possible, however, to pay a lump sum into a trust or make payments over time (which, if calculated correctly, can be treated as a maintenance payment to your children and not taxable to IHT at all), which can both provide for your children's education should you die before it is complete, and reduce your estate for IHT in case you die in the seven years following the payment.
These trusts are not considered in detail in this article.
Are there any disadvantages of an Educator Trust?
Once assets are gifted into trust, you will never be able to be able to benefit from them in the future, so you will need to ensure that you have sufficient assets to give away.
Trusts have ongoing compliance and reporting requirements, such as being registered with HMRC.
These are more demanding on Discretionary ETs than Bare ETs.
Someone will need to deal with these requirements, and if a professional is instructed, there will be costs for this.
These costs can be paid from the ET, however.
Depending on the capital growth of a Discretionary ET, there may be charges to IHT every ten years, at no more than 6% on anything over (typically) £325,000.
What happens to any funds not used?
For a Bare ET, once the beneficiary turns 18, they are entitled to the money and can demand the trustees pay it over to them - something that you may wish to avoid!
For a Discretionary ET, your Trustees can decide who can benefit from the unused assets out of a pool of beneficiaries you select.
The trust can continue for up to 125 years, so it could cater for the education of future generations or be used to help your grandchildren in life, such as to get on the property ladder.