How to invest to pay for school fees

There’s a chill in the air and a smile on parents’ faces. Summer may be over, but school has begun, and with its arrival comes respite from the six-plus weeks of entertainment, exercise and administration.

But what’s this looming over the horizon? For the parents of the half a million children in private education, it’s a big fat hike in school fees. From January 1, private schools will no longer be eligible for tax breaks – such as charitable business rate relief – which currently means they do not charge VAT on school fees.

Any fees paid from 29 July 2024 relating to the term starting in January 2025 and onwards will be subject to VAT. The Labour Government has introduced the changes in order to raise funds of around £1.5bn a year to improve standards in state education.

School fees are currently an average of £6,021 per term for day pupils, totalling £18,064 a year. Over the course of the seven years of secondary education, assuming 3.5pc inflation, you’re looking at a bill of £140,522. Add VAT to this and it jumps £28,000 to £168,633.

These numbers mean that the choice of private education is not available to all, but for those with sufficient disposable income, a bit of forward planning goes a long way.

The earlier you start to save for school fees – or indeed university fees, which have seen similar cost hikes in recent years – the better. As with any investment goal, it is time in the market not timing the market that makes the biggest difference to the size of your portfolio.

Utilising tax wrappers to boost your investments earnings potential by mitigating the erosion of tax will help further. Pay in lump sums to an Isa, or even better, set up a direct debit for payday. The current annual Isa allowance is £20,000 per person – don’t forget to utilise both parents’ allowances to maximise the benefit.

If you’ve already maxed out your Isa allowances you could consider setting up a bare trust, where an adult invests on behalf of a child. These mature at 18 when the child would be able to access the assets but can be used before then if for the benefit of the child. School fees qualify.

There are tax benefits to bare trusts – income and gains are usually treated as belonging to the child, so they’re generally tax free within allowances. The exception to this is where money is paid into the trust by a parent and the income raised from it is £100 or more, in which case it is taxed at the parent’s marginal rate.

Parents should make sure they pick the accumulation share class of any income paying fund to avoid this. Or ask a grandparent to contribute instead!

Where to invest

Investment ideas for school fees should be mindful of the end goal. As with any financial goal with a fixed deadline and financial requirement, risk should be carefully considered. If you are paying school fees in less than five years, capital preservation is key, in which case cash or cash-like assets are your best option. Use a savings platform to compare interest rates.

With a longer term horizon you can consider more investment risk. Developed markets – while not always smooth sailing – are likely to have less volatility than investments in emerging economies.

The Fidelity Index World passive tracker fund invests across a broad range of developed countries like the US, Japan and European countries including the UK. It offers exposure to large and medium-sized companies including household names like Microsoft, Apple and Amazon.

Blend this choice with a more defensively managed fund, upping the allocation to the defensive option as you approach fee day. Troy Trojan or Ninety One Diversified Income fund are both a step up in risk from cash but suitable for investors looking for capital preservation and total returns.

Education trusts and estate planning

If you are lucky enough to have a larger lump sum, such as those gifted through estate planning,  which you wish to use to pay for several children’s education, you could set up an educational trust with the children as beneficiaries.

A trust set up specifically for education means just that – the proceeds have to be used for that purpose, which can give comfort to the grantees. Grandparents may find it more palatable to support grandchildrens’ education rather than leave a lump sum in a will over which they will have no sway.

There are a couple of different ways in which to do this and normally a transfer of cash into a trust up to the inheritance tax threshold of £325,000 per person is free from immediate charge to inheritance tax.

There will be costs involved in setting up and running the trust, which could include ongoing and exit inheritance tax charges, and income and capital gains tax payable on assets in the trust. However, depending on how the trust is structured it may be possible for any income tax and capital gains tax paid on the assets in the trust to be reclaimed using the child’s allowances.

Discounts and bursaries

As well as planning ahead, it is worth speaking to the school of your choice about payment and funding options. Children of parents in the armed forces, duplicate children and children of teachers can often get discounts. Paying for one or more years up front can often mean you can negotiate fees downwards.

If your child is particularly gifted academically, or in sports or music, there are always scholarships to consider. Better get practising that violin concerto.