Helen O’Hagan, Technical Manager at Prudential, looks at some of the options to help fund the cost of going to university.
An exciting time for children but not so much for their parents if they have not made financial provision to plan for this expense.
And expensive it is! Not only the major items like tuition fees and accommodation but what about the cost of living – rent, bills, food, books, broadband, mobile phones, travel and let’s not forget the beer! The list is endless and unless you started saving early how are you and your children going to foot the bill?
Let’s take a look at the actual costs. According to the ‘The complete university guide’, it can cost up to £85,000 per child, per degree. It all depends on the geographical location of the university the child has chosen for their degree.
Using a growth rate of 3% net, it will cost £608 per month over 10 years to save £85,000. Or with a capital lump sum to invest, £55,000 over 10 years should give enough to fund one child.
This is a huge expense and if you have more than one child you have to multiply this up.
There are a lot of people who have left it too late to fund for this cost and unfortunately their kids may be saddled with debt for a long time to come.
Example – Margaret the Grandmother
Margaret is a much-loved gran who has decided to help her children fund the university fees for her grandchildren. She is a sprightly 80-year-old widow with four children and several grandchildren and lives a very comfortable lifestyle.
Margaret has more than enough income from her pensions and investments, however, her estate is way over the Inheritance Tax (IHT) thresholds and she is very concerned about the amount of tax which will go to HMRC on her death.
Her financial adviser tells her that HMRC receipts in respect of inheritance tax are on the up, and that IHT is a voluntary tax because it can be easily mitigated by use of trust planning. If Margaret does not consider some IHT planning, her estate over the available thresholds will be subject to 40% IHT which will line the coffers of HMRC instead of being available for her family.
Margaret tells her adviser that she is very keen to help her sons and daughters with the cost of university for their children and wants to know if she can combine both i.e. do some IHT planning and help her grandchildren through university should they decide to go. She has never entered into any kind of trust planning previously but is open to ideas.
Her adviser informs her that there are two trusts commonly used for university planning – gift trusts and loan trusts. Firstly, he talks her through a typical gift trust and states they are commonly used by clients who want to do IHT planning and retain control over their gift but there is no access at all for Margaret. If Margaret isn’t comfortable giving up access to her capital she ought to think about using a loan trust.
This type of trust allows Margaret access to her capital but the growth will be inside the trust and not her estate on death.
Under both, the trust fund will be available to the beneficiaries to help with the cost of university.
In Margaret’s case, she is more than happy to tie up her capital as she already has sufficient funds now and for her future needs. She doesn’t see any reason at all why she would need to have any access.
Her adviser explains there are two types commonly available which are Absolute gift trusts and Discretionary gift trusts.
Absolute trusts are normally used for minor children due to the fact that on reaching age 18 (16 if written under Scot’s law) the beneficiary is entitled to the trust fund.
Discretionary trusts offer the most flexibility for the trustees, there are classes of beneficiaries and no one has any entitlement to the funds. Under a Discretionary trust it’s up to the trustees to decide who will benefit and when they will benefit from the trust fund. As long as the beneficiary is in the class of beneficiaries the trustees can allocate funds to them.
Margaret isn’t keen at all for the children or grandchildren to have access, she very much wants to be in control of her funds. She is very conscious that one of her children is going through a tricky patch in their marriage and she certainly doesn’t want any of her hard earned cash ending up as part of a divorce settlement. Then there’s her son’s gambling habit to consider, he can’t be trusted to look after any large lump sums. This is the reason she is keen on using a trust rather than handing over her cash to her family.
Her adviser tells her that she will be the first named trustee and she should choose her trustees wisely as ultimately, they will be dealing with the trust fund. It’s advisable for her to lodge a letter of wishes with the trustees to give them some guidance, after her death, as to how she wants the trust fund divided up. He also reminds her that a discretionary beneficiary cannot demand monies from the trustees and nor does this form part of their estate for divorce, bankruptcy or inheritance tax whilst inside the trust.
Her adviser discusses the options with her and because this investment will be wrapped in trust and assets that don’t provide income are simple and tidy within a trust environment, she opts for a single premium life assurance bond. She has the option of onshore investment bonds or offshore investment bonds.
As Margaret is setting this money aside for a long time to benefit her grandchildren and who will most likely be non-tax payers, she is opting for an offshore capital redemption bond. This will ensure that the investment lasts until all the grandchildren who want to go to university can get help from the trust fund without the investment coming to an untimely end. Her adviser has also suggested that that she should take the maximum number of segments within the bond to give flexibility within the trust allowing assignation to the beneficiaries.
Her adviser explains to her that as she is a higher rate tax payer and the rate of tax applicable to discretionary trusts is 45%, the trustees may want to consider assigning segments to the beneficiaries when they need funds.
An assignment from the trustees to a beneficiary is not a chargeable event – it is a distribution from the trust fund. If the beneficiary later encashes those segments, then the gain will be chargeable on the beneficiary.
The trustees can only assign the segments once beneficiaries reach age 18 which is fine as this is being used to fund university. Her adviser tells her that for example if Jenny, the oldest granddaughter, decides to go to university at age 18 the trustees can assign some segments to her. If Jenny is a poor student and has no income, under current rules she will be able to use her personal allowance, the £5,000 savings rate, the £1,000 PSA and any 5% tax deferred allowance. It’s very unlikely that she will have any tax to pay.
If Margaret decided to take out an onshore bond instead, as the funds are taxed internally on the insurance company, this satisfies any basic rate liability. This means that slice on the bond would have to push Jenny into higher rate tax before she has anything to pay.
Margaret is delighted with this solution, she is killing two birds with one stone. After 7 years the gift will be outside her estate for IHT purposes and she feels that she is putting the money aside for a very worthy cause indeed investing in her grandchildren’s’ future.
For further information on intergenerational planning take a look at Prudential’s Life Events hub on PruAdviser.